KPMG report: Analysis and observations about proposed regulations, FATCA burden relief

The U.S. Treasury Department and IRS have released proposed regulations ("Proposed Regulations") under chapters 3 and 4 of the Internal Revenue Code, containing modifications resulting from industry comments and intended to provide burden relief under chapter 4 (FATCA) and chapter 3.

The Proposed Regulations [PDF 253 KB] appear in the December 18, 2018 edition of the Federal Register.

Specific highlights and discussion of the modifications are described below.


Elimination of FATCA withholding on gross proceeds

Subject to certain exceptions, the definition of a “withholdable payment” under the FATCA regulations has historically included: (1) payments of U.S. source fixed or determinable annual or periodical (FDAP) income; and (2) gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends that are U.S. source FDAP income. Notwithstanding the previous sentence, however, Treasury and the IRS have repeatedly issued guidance deferring the date on which gross proceeds would be treated as withholdable payments subject to FATCA withholding. Prior to release of the Proposed Regulations, gross proceeds were scheduled to be treated as withholdable payments for transactions occurring on or after January 1, 2019.

Rather than including another deferral, the Proposed Regulations remove gross proceeds from the definition of withholdable payment entirely. This change permanently eliminates FATCA withholding on gross proceeds.

KPMG observation

The statutory definition of withholdable payment under IRC section 1473(1)(A)(ii), which includes “any gross proceeds from the sale or other disposition of property of a type which can produce interest or dividends from sources within the United States,” remains unchanged. However, this statutory definition is premised with the caveat, “Except as otherwise provided by the Secretary….”  Treasury and the IRS have relied upon this language to write gross proceeds out of the definition entirely. While this was previously believed by many to exceed Treasury’s authority (as the regulatory definition now omits half of the statutory definition), the permanent elimination of withholding on gross proceeds is a welcome change by the industry that is unlikely to be challenged.  


Deferral of FATCA withholding on foreign passthru payments

The FATCA regulations generally require a Participating Foreign Financial Institution (PFFI) to withhold on any “foreign passthru payment” it makes to a recalcitrant account holder or a foreign financial institution that fails to comply with FATCA (i.e., a nonparticipating FFI, or NPFFI). A foreign passthru payment generally refers to any payment to the extent such payment is attributable to a withholdable payment—see section 1471(d)(7)however, the Treasury regulations reserve on any detailed definition of a foreign passthru payment

As with gross proceeds, Treasury and the IRS have repeatedly issued guidance deferring the date on which foreign passthrough payments are subject to withholding. The Proposed Regulations continue this pattern, further delaying a PFFI’s requirement to withhold on foreign passthru payments made to recalcitrant account holders and NPFFIs until the date that is two years after final regulations defining the term “foreign passthru payment” are published in the Federal Register.

KPMG observation

While the Proposed Regulations further delay withholding requirements with respect to foreign passthru payments, the preamble makes it clear that Treasury and the IRS still believe that, unlike gross proceeds, withholding on foreign passthru payments remains an important tool for achieving FATCA’s goal of preventing tax evasion. The preamble elaborates that foreign passthru payment withholding may be necessary to ensure that non-compliant financial institutions do not attempt to evade FATCA withholding by investing through “blockers” that produce only non-U.S. source income. Treasury and the IRS have solicited further comments from the public on ways to efficiently implement these withholding requirements, which suggests a renewed interest in eventually implementing withholding on foreign passthru payments.


Elimination of FATCA withholding on non-cash value insurance premiums

The potential for FATCA withholding on non-cash value insurance premiums has historically strengthened the IRS’s enforcement efforts in the passive foreign investment company (PFIC) context by encouraging reporting of U.S. owners in order to avoid FATCA withholding on premiums received by the entity. The new U.S. tax law (Pub. L. No. 115-97, also referred to as the “Tax Cuts and Jobs Act”) narrowed the availability of certain PFIC reporting exceptions, however, therefore diminishing the enforcement value of FATCA withholding as the U.S. owners may now be reported for PFIC purposes. In response, Treasury and the IRS have eliminated FATCA withholding on non-cash value insurance premiums by including such premiums in the definition of an “excluded nonfinancial payment,” meaning that such payments are no longer considered withholdable payments subject to FATCA withholding.

KPMG observation

The elimination of FATCA withholding on non-cash value insurance premiums will provide substantial relief for members of the insurance industry. Prior to this change, insurance brokers and other entities paying premiums were required to collect Forms W-8 from all insurance companies, even those that did not issue cash value insurance products (and thus were likely not FFIs under FATCA). As these payments did not generally need to be documented for chapter 3 purposes, obtaining such documentation strictly for FATCA caused a substantial change in due diligence obligations for the insurance industry. This rule change now scales back the collection of documentation for insurance premiums and limits the focus to insurance premiums that are likely to be made to FFIs, or intermediaries acting on behalf of FFIs.


Clarification of the definition of a managed investment entity under FATCA

The definition of an investment entity (and therefore a financial institution) generally includes any entity whose gross income is primarily attributable to investing, reinvesting, or trading in financial assets, if such entity is “managed by” another entity that is a financial institution.* Treasury and the IRS have clarified this definition to eliminate potential over- and under-inclusions under prior guidance.

The Proposed Regulations clarify that an entity will not be considered “managed by” another entity solely because the first-mentioned entity invests all or a portion of its assets in a mutual fund, an exchange traded fund, or a collective investment entity that is widely held and is subject to investor protection regulation.

The Proposed Regulations further clarify that an entity will be considered “managed by” another entity if the second-mentioned entity is managing the assets pursuant to a discretionary mandate (i.e., investing the first entity’s assets directly in accordance with the first entity’s investment goals).  

* An entity will not be considered an investment entity if the managing financial institution itself only qualifies as a financial institution under this definition (i.e., a managed investment entity).


KPMG observation

The updated definition in the Proposed Regulations helps align the FATCA definition of a managed investment entity with the corresponding definition under the OECD Common Reporting Standard. This should help avoid unintended discrepancies across the regimes and make financial institution classifications more consistent.

As with foreign passthru payments, Treasury and the IRS have specifically solicited additional comments regarding the definition of investment entities. This request suggests that Treasury and the IRS are considering further refinements of the definition and may issue further guidance based on comments received. Taxpayers with any concerns or suggestions should submit comments accordingly.


Revised requirements for treaty statements under chapter 3

Foreign persons may generally claim treaty benefits on payments received by providing the withholding agent with a treaty statement either on a withholding certificate or accompanying supporting documentary evidence. Treasury Regulations released in 2017 (2017 Regulations) added a requirement that a treaty statement provided with documentary evidence must also include the specific limitation on benefits (LOB) provision in the treaty under which the claimant qualifies, and however, also included a transitional rule permitting withholding agents until January 1, 2019, to rely on treaty statements that do not contain LOB provisions, provided the treaty statements were received prior to January 6, 2017 (Preexisting Treaty Statements). The 2017 Regulations also limited the validity period for treaty statements to the end of the third calendar year after the treaty statement was provided (three-year validity rule).

The Proposed Regulations extend the transitional rule for treaty statements an additional year. As a result, withholding agents may rely on Preexisting Treaty Statements that do not contain LOB provisions until January 1, 2020, (rather than January 1, 2019).

In addition, the Proposed Regulations provide an exceptions to the three-year validity rule for treaty statements that rely on an LOB provision for a tax-exempt organization (other than a tax-exempt pension trust or pension fund), government, or publicly traded corporation. Treaty statements relying on one of these LOB provisions may be valid indefinitely.

Finally, the Proposed Regulations clarify that an actual knowledge standard applies to a withholding agent relying on an LOB provision contained on a treaty statement. This is the same standard that applies to a treaty claim made on a withholding certificate.

KPMG observation

In order to treat a treaty statement as indefinitely valid based on an LOB provision applicable to publicly traded entities, the withholding agent must determine, based on publicly available information, that the entity is publicly traded each time the treaty statement would otherwise be up for renewal (i.e., every three years) and must retain a record of the information relied upon for the determination. Accordingly, withholding agents that intend to utilize this relief will need to implement back office procedures sufficient to satisfy this additional due diligence requirement. This additional due diligence requirement does not apply to entities relying upon the LOB provision for tax-exempt organizations or governments.

The treaty statement provisions contained in the Proposed Regulations will also be incorporated into the 2017 qualified intermediary (QI) Agreement and 2017 withholding foreign partnership (WP) and withholding foreign trust (WT) Agreements, and QIs, WPs, and WTs are permitted to rely upon these modifications in the Proposed Regulations until such time. While the extension of the transition period for the LOB provision to January 1, 2020, should be a welcome change across the board, the general imposition of the three-year validity rule created additional burdens for QIs that were not completely ameliorated by the modifications in the oroposed regulations, as the QI agreement initially allowed QIs to treat all treaty statements as indefinitely valid (subject only to the actual knowledge standard). Accordingly, though the updates in the Proposed Regulations should be welcome, QIs may continue to struggle with the additional due diligence burden imposed with respect to treaty statements by the 2017 Regulations. The 2014 WP and WT Agreement permitted a WP and WT that was bound by anti-money laundering and “know your customer” legislation, to use the same alternative documentation rules contained in the QI Agreement. Like the prior versions of the QI Agreement, the validity period of the treaty statement was aligned with the documentary evidence (i.e., generally indefinite absent a change in circumstances). Accordingly, WPs and WTs face similar challenges under the 2017 agreements.


Revised treatment of “hold mail” instructions under FATCA and chapter 3

Under prior guidance, an address could be treated as a permanent residence address despite being subject to a “hold mail” address if the person provided documentary evidence establishing residence in the country in which the person claimed to be tax resident. The Proposed Regulations ease this requirement for persons not making treaty claims. Specifically, the modified rule states that the documentary evidence provided by an account holder whose only address is subject to a hold mail instruction and who is not claiming a treaty benefit is any documentary evidence that supports the person’s claim of foreign status. For persons making treaty claims, however, the documentary evidence provided must continue to support the person’s claim of residence in the specific country for which the treaty benefits are being claimed. The types of documentary evidence withholding agents may rely on in applying the above rules are generally described in Reg. section 1.1471-3(c)(5)(i), except that documentary evidence obtained for this purpose does not need to contain a permanent residence address.

KPMG observation

This modification to the standards for curing hold mail instructions is a welcome change as previously the standards for curing hold mail addresses were higher than the standards for curing U.S. addresses. That discrepancy did not make much sense, as the concern over hold mail addresses was that the account holder or payee was potentially hiding a U.S. address. The modifications in the Proposed Regulations now provide consistent cures for both types of indicia.

The Proposed Regulations further clarify that a person’s request to receive all correspondence electronically, including account statements, does not constitute a hold mail instruction.

KPMG observation

While many withholding agents were already interpreting the rule in this manner (i.e., not treating requests to receive all correspondence electronically as hold mail instructions), the Proposed Regulations eliminate any potential ambiguity in the rule.


Updates to Forms 1042 and 1042-S reporting and deposit procedures

The Proposed Regulations modify the Form 1042-S reporting and depositing requirements for partnerships that earn U.S. source income but that do not distribute such income to partners in the year in which the income is earned by the partnership. In this case, the payment is treated as made to the foreign partners on the earlier of the date it is actually distributed to the partner or the date in which the Schedule K-1 is filed, or is required to be filed (i.e., by September 15th of the subsequent year at the latest).

The Proposed Regulations generally require the partnership to report these payments to its foreign partners on Forms 1042 and 1042-S for the year in which the income was earned by the partnership (even if the distributions were actually, or deemed to have been, made in the subsequent year). Under prior guidance, such amounts were instead reported in the subsequent year pursuant to the lag method. The Proposed Regulations make corresponding changes to the deposit rules, now requiring that the deposits of amounts withheld from distributions to the partner be attributed to the year in which the underlying income was earned by the partnership.

Notwithstanding the previous paragraph, the Proposed Regulations provide an exception for non-calendar year partnerships (i.e., fiscal year partnerships). Such partnerships may, but are not required to, report distributions to partners on Forms 1042 and 1042-S, and designate deposits, for the year in which the distribution occurs (i.e., in line with the lag method required under prior guidance).

When a partnership withholds on a distribution after March 15th of the year following the year the underlying income was earned by the partnership but the partnership attributes the deposit to the prior year in which the partnership earned the income (i.e., in line with the new rule), the due date for the associated Form 1042-S is postponed until September 15th. The IRS intends to add a check box to Form 1042-S so that the withholding agent can indicate when it qualifies for the September 15th due date.

KPMG observation

While the preamble to the Proposed Regulations primarily focuses on the partnership context, the Proposed Regulations require withholding agents to report the tax liability and deposit with respect to the prior year (i.e., the year of payment rather than the year in which the withholding occurs) in all cases in which a withholding agent is permitted to withhold in the year following the year of payment.  Examples of such situations may include spillover dividends and withholding under section 305(c).

With respect to partnerships, the Proposed Regulations appear to effectively end the requirement for partnerships to follow the prior “lag method” of reporting. KPMG tax professionals have noted that the regulations specifically address partnership reporting when withholding is required but do not specify whether the change in reporting will apply to amounts for which withholding is not required (such as amounts falling within the portfolio interest exception or subject to complete relief under a treaty). Forms 1042 and 1042-S reporting instructions for 2019 would be expected to provide clarity on this point; however, given that the purpose of the Proposed Regulations is burden relief, it seems unlikely that Treasury and the IRS would require a partnership to split reporting between two years. Therefore, it is anticipated that the intent of the Proposed Regulations is to effectively end the lag method of reporting entirely for partnerships, other than fiscal year partnerships that elect to remain on the lag method.    

When the postponed due date for Form 1042-S reporting applies, the due date will align with a calendar year partnership’s extended deadline for furnishing a partner’s Schedule K-1. This change allows the partnership to delay filing of the Form 1042-S until it has the income information it needs from the Schedule K-1 and, therefore, would better align tax reporting to foreign partners. 


The Proposed Regulations also revise the Form 1042-S reporting procedures for nonqualified intermediaries (NQIs) who have been withheld upon under FATCA because they did not provide necessary information regarding beneficial owners. Specifically, when an upstream withholding agent imposes FATCA withholding on a payment reported to an unknown recipient with the NQI as the intermediary, the NQI may then report the payment to its payee as subject to chapter 3 withholding, instead of FATCA withholding, provided that (1) the NQI is a participating FFI or registered deemed-compliant FFI, and (2) the NQI can confirm that, based on the payee’s chapter 4 status, the payment should not be subject to FATCA withholding.

KPMG observation

This change was implemented to help the underlying account holders of NQIs claim tax credits in their respective jurisdictions of residence in the circumstances described above. Reporting the withheld amounts as FATCA withholding was previously causing issues when these underlying owners tried to claim tax credits, as some jurisdictions do not regard FATCA withholding as a creditable income tax.


Updates to the reimbursement and set-off procedures

The Proposed Regulations also provide modifications for the deadlines with respect to the reimbursement and set-off procedures, which each provide a method for remediating over-withholding without requiring the payee to file a refund claim with the IRS. Under prior guidance, adjustments made under these procedures were required to be made prior to the original due date of Form 1042-S. The Proposed Regulations extend the deadline for a withholding agent to refund a beneficial owner or payee under the reimbursement and set-off procedures from the original due date of Form 1042-S (i.e., March 15th) to the extended due date (i.e., 30, or in rare cases, 60 days after the original due date).

KPMG observation

The withholding agent must report the amount of tax withheld and the amount of the actual repayment on a timely filed (including extensions) Form 1042-S. The withholding agent must also include the amount of adjustments made to over-withholding and the amount of credit claimed on a timely filed (including extensions) Form 1042.

Note that partnerships eligible for the September 15th Form 1042-S filing deadline (for amounts not distributed in the year earned by the partnership and withheld on or after March 15th) should now have until September 15th to apply the reimbursement and set-off procedures.

The Proposed Regulations further require that any refunds to beneficial owners or payees under these procedures be made prior to the date the Form 1042-S is furnished to such beneficial owner or payee.

KPMG observation

Prior guidance required that refunds to beneficial owners or payees be made prior to the time the associated Forms 1042-S were filed with the IRS, but did not make any reference to the date the Forms 1042-S were furnished to the beneficial owner or payee. This additional deadline under the Proposed Regulations helps ensure that the Form 1042-S furnished to a beneficial owner or payee properly reflects any repayments made under these procedures and is consistent with the Forms 1042-S filed with the IRS.


Effective date

Taxpayers may rely on the Proposed Regulations until final regulations are issued—except taxpayers may apply the modifications in the Proposed Regulations for all open tax years until final regulations are issued with respect to: (1) the elimination of withholding on non-cash value insurance premiums; (2) the clarification of the definition of a “managed by” investment entity; and (3) the revised allowance for a permanent residence address subject to a hold mail instruction.

With respect to the revisions relating to credits and refunds of withheld tax, taxpayers may not rely on these Proposed Regulations until Form 1042 and Form 1042-S are updated for the 2019 calendar year.

KPMG observation

Note that while QIs, WPs, and WTs, may also avail themselves to the modified reimbursement and set off procedures outlined in the Proposed Regulations, they similarly should be bound by the effective date provided above (i.e., not until the forms are updated for the 2019 calendar year).


For more information, contact a KPMG tax professional:

Laurie M. Hatten-Boyd

Danielle Nishida

Carson Le






Mark Naretti

Steven M. Friedman

Sarfraz A. Khan

Elis A. Prendergast

Mike Chan

Danielle Bloom

Paul Malboeuf

Terence Coppinger

Samuel Naso

Kelli Wooten

Tara Thomas

Cyrus Daftary

Thomas Bramlage

Andrew McQuilkin


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