ACTEC Comments on Proposed Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities (REG-121647-10) Released February 15, 2012

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April 30, 2012
CC:PA:LPD:PR (REG- 121647-10)
Internal Revenue Service
Room 5205
Post Office Box 7604
Ben Franklin Station
Washington, DC 20044
Sent Electronically via the Federal eRulemaking Portal at (IRS REG-121647-10)
Re: Comments of The American College of Trust and Estate Counsel on the Proposed Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities (REG-121647-10) Released February 15, 2012
Dear Ladies and Gentlemen:
The College is a professional organization of approximately 2,600 lawyers from throughout the United States. Fellows of the College are elected to membership by their peers on the basis of professional reputation and ability in the fields of trusts and estates and on the basis of having made substantial contributions to those fields through lecturing, writing, teaching, and bar activities. Fellows of the College have extensive experience in providing advice to taxpayers on matters of federal taxes, with a focus on estate, gift, and GST tax planning, fiduciary income tax planning, and compliance. The College offers technical comments about the law and its effective administration, but does not take positions on matters of policy or political objectives.
If you or your staff would like to discuss the recommendations, please contact Ellen K. Harrison of Pillsbury Winthrop Shaw Pittman, LLP in Washington, D.C. at (202) 663-8316, or or Henry Christensen, III of McDermott Will & Emery in New York, New York at (212) 547-5658, or Review was provided by Ronald D. Aucutt, Chair of the ACTEC Washington Affairs Committee, at (703) 712-5497, or
Respectfully submitted,
Louis A. Mezzullo

These comments discuss only those aspects of the Proposed Regulations that impose reporting obligations (i) on U.S. beneficiaries of foreign trusts and estates, (ii) on fiduciaries of foreign trusts and estates and of domestic trusts and estates that may have foreign accounts, and (iii) on foreign financial institutions (“FFIs”) that hold accounts for domestic or foreign trusts or estates. We would like to assist the Treasury Department in crafting and adopting understandable and administrable Regulations that will ensure, at acceptable costs to institutions and fiduciaries, that the Treasury Department receives all the information we understand it needs and seeks.
These comments are divided into two sections. The first section discusses some overarching policy issues that we believe are fundamental to structuring the approach to trusts the Final Regulations should take. We note that there are no provisions in the Proposed Regulations that deal specifically and in detail with trusts, and we suggest that there should be. The second section of these comments offers technical comments on certain provisions in the Proposed Regulations.
A. Should Foreign Trusts Be Treated as Foreign Financial Institutions (“FFIs”)?
In ACTEC’s Report filed with the Treasury Department on January 7, 2011concerning the FATCA provisions of the HIRE Act and Notice 2010-60, we questioned whether a foreign trust should be treated as a Foreign Financial Institution, or FFI, as defined in Section 1471(d)(4) and (5), or as a Non-Financial Foreign Entity, or NFFE, as defined in Section 1472(d).  Notice 2010-60 suggested, but did not expressly state, that trusts should be treated as FFIs.  The Proposed Regulations similarly suggest, but do not expressly state, that foreign trusts will be treated as FFIs under the Final Regulations.  For example, Proposed Reg. §1.1471-3(d)(7)(iv)  speaks of “[a]n FFI that is a partnership, simple trust, or grantor trust.”  We urge that the Final Regulations expressly confront this question, and that Treasury consider the impact of treating foreign trusts as FFIs.
In ACTEC’s January 7, 2011 Report, we suggested that in our view a foreign trust could be found to be an FFI only as a “Type iii” Section 1471(d)(5)(C)FFI, which is an entity that “is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities (as defined in section 475(c)(2) without regard to the last sentence thereof), partnership interests, commodities (as defined in section 475(e)(2)), or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities.”  We did not think that a trust could be a “Type i” FFI, which “accepts deposits in the ordinary course of a banking or similar business,” although a trust company might fit such a definition.  We also did not think that a trust should be treated as a “Type ii” FFI, which “as a substantial part of its business, holds financial assets for the account of others.”  Our difficulty with applying these rules to trusts as such is that under Treasury Reg. §301.7701-4 the two fundamental ways in which trusts are distinguished from associations or corporations is that trusts do not have associates, but rather have a trustee who takes title to property for the purpose of protecting or conserving it for the beneficiaries, and trusts do not hold themselves out as engaging in business.
Other professional organizations shared ACTEC’s concerns about treating foreign trusts as FFIs.  We understand why Treasury seeks to obtain full information about the beneficiaries of trusts, but we suggest that all needed information can be obtained without treating foreign trusts as FFIs and urge that this issue be considered carefully in crafting final regulations.  Alternatively, if trusts are to be classified as FFIs, simplified reporting obligations should be imposed to qualify as participating FFIs which require only that trusts report distributions made to U.S. beneficiaries in recognition of the fact that beneficiaries of trusts do not have separate accounts.
B. Should the FATCA Rules Apply to Trusts, or to Trustees?
Trust lawyers recognize that under the common law a trust does not exist as an entity.  Rather, the Trustee holds legal title to property for the equitable benefit of the trust beneficiaries, who are given the right to enforce their interests in chancery or equity courts.  Under the Internal Revenue Code, generally, trusts are treated as entities, and trustees are not treated as taxpayers. Rather, the trustee is similar to an officer or director of a corporation who has the obligation to pay the tax liabilities of the trust, and the trust itself is the taxpayer under Subchapter J of the Internal Revenue Code.  We believe that Treasury intends to take the same approach with respect toFATCA, but we suggest that it do so expressly.  For example, an individual trustee (and many millions of trusts have individual, not corporate, trustees) could not be an FFI under Section 1471(d)(4), because an individual is not an “entity,” and only “entities” can be FFIs. The Final Regulations should make clear that they apply to FFIs and to NFFEs, and that trusts are one or the other, but that trustees are not separately subject to the rules.
C. Consideration Should Be Given to What Information Treasury Needs to Have Regarding Foreign Trusts and Their Beneficiaries.
At a meeting ACTEC representatives had with representatives of the Treasury Department in 2011 to discuss our January 7, 2011 filing, we were given to understand that, with respect to foreign trusts, the information that Treasury felt it must have was full information on ownership of foreign trusts by U.S. persons (whether under Section 679 or otherwise), such that the U.S. person should be reporting the income of the foreign trust currently on his or her U.S. income tax return, Form 1040, as well as timely information on distributions made to U.S. persons that they should be reporting to the Internal Revenue Service, but may not be reporting.  Under current Section 6048, any U.S. person who is treated as the owner of a foreign trust is required to see to it that the trust files a current return, on Form 3520-A, of the income and deductions of the trust, and then to report himself or herself all of that income and deductions with a Form 3520 filed with his or her Form 1040 for the year.  Further, any beneficiary of a foreign trust is required to file a Form 3520 that discloses all distributions that the beneficiary received from the foreign trust during the tax year. The new Form 8938 called for by the new Section 6038D, another part of FATCA, increases reporting responsibilities for U.S. taxpayers having interests in foreign accounts, but again does not require reporting by the FFI with respect to the account.
There is at this time no requirement that the foreign trust file a report with the Treasury Department, on a Form 1099 or Schedule K-1, disclosing all distributions made to U.S. persons during the tax year.  This is the information, taxable income, that Treasury needs to have each year.  It does not seem to us that Treasury needs to know who all possible discretionary beneficiaries of a foreign trust might be, if they have not received any income.  To the extent that the FATCA regulations are to apply to foreign trusts as such, and not just to FFIs (banks, brokers, custodians, and the like) that hold accounts for foreign trusts, we urge that Treasury direct its efforts to obtaining timely reports from the foreign trust of any distributions it has in fact made to a U.S. person, rather than exhaustive, and unneeded, information on all possible discretionary beneficiaries.  As we have discussed with representatives of the Treasury Department, many, if not most, offshore trusts are broad discretionary trusts for the possible benefit of a donor’s entire family.  Disclosure of the names, addresses, and taxpayer identification numbers of all of those persons, many or most of whom may be nonresident aliens of the United States, would be intrusive and unduly expensive, and would not serve the needs of the United States Treasury in collecting tax obligations of U.S. taxpayers.
A. Rules Applicable to Accounts of Trusts Held by FFIs
Generally, we believe that the rules in the Proposed Regulations applicable to the reporting obligations of FFIs that hold accounts for trusts are sound and workable.  Trusts, whether domestic or foreign, that hold deposit or investment accounts with banks, brokers, or custodians must report sufficient information to the FFI to allow it to comply with FATCA.
Proposed Reg. §1.1471-5(a)(3)(i) states that, in general, “if a trust (including a simple trust or grantor trust) or an estate is listed as the holder or owner of a financial account, the financial account shall be treated as held by the trust or estate itself rather than by its owners or beneficiaries.”  The statute (Section 1471) provides that an FFI must obtain required information about each “holder” of each “account” at the FFI (Section 1471(b)(1)(A)), and that, in the case of a foreign account holder, the FFI must obtain further information about each “substantial United States owner” of the foreign entity (Section 1471(c)(1)(A)).  Thus, in the case of a U.S. domestic trust that holds an account at the FFI, the FFI need only obtain the required information about the trust itself, because the trust is a U.S. taxpayer and all income passing through the trust will be reported to the Internal Revenue Service.
In the case of a foreign trust that holds a financial account with an FFI, the FFI must obtain information on all “substantial United States owners” of the foreign trust. Section 1471(c)(1)(A).  For this purpose, it is not necessary to determine whether the foreign trust is to be treated as an FFI or as an NFFE, because it is a foreign entity maintaining a financial account with an FFI.  Generally, under the Code, a “substantial United States owner” of a foreign trust is either the “owner” as determined under the grantor trust rules (Section 1473(2)(A)(iii)(I)), or the holder of more than a 10 percent interest, as determined under Regulations, of a foreign trust that is not a grantor trust (Section 1473(2)(A)(iii)(II)).  The statute has a special rule, in Section 1473(2)(A)(B), that “Type iii” investment vehicles described in Section 1471(d)(5)(C ) shall have a “0 percent” threshold, rather than a 10 percent threshold, for determining “substantial United States owners.”  This may have troublesome implications for trusts, as discussed below.
With respect to financial accounts held at FFIs for foreign trusts that are not “grantor” trusts with United States owners, Proposed Reg. §1.1473-1(b)(1)(iii)(B) states that generally a substantial United States owner is “[a]ny specified U.S. person that holds, directly or indirectly, more than ten percent of the beneficial interests of such trust.”  We suggest that this Regulation define a substantial United States owner as “any specified U.S. person that holds, directly or indirectly, more than ten percent of the beneficial interest in the distributable net income of such trust, as defined [for a foreign trust] in section 643(a)(6).”  We suggest this definition because, actuarially, in the case of a trust with fixed interests, the remainder beneficiary may hold an interest having a value of more than ten percent of the whole of the value of a foreign trust, but nevertheless have no interest in the income of the trust.  It seems to be only the beneficiaries having an interest in the income of the trust that Treasury needs information about for purposes of FATCA.
We also note that the Proposed Regulations deal specifically with foreign trusts deemed to be owned by U.S. persons, but not with foreign trusts deemed to be owned by foreign persons, from which distributions are or may be being made to U.S. persons.  We would suggest, for clarity, that a new subparagraph be added to the Proposed Regulations, perhaps as a new Proposed Reg. §1.1473-1(b)(1)(iii)(C), which could state:
To the extent the trust is deemed owned by a nonresident alien person under the rules of Subpart E of Subchapter J, in particular section 672(f), no U.S. person shall be deemed to be a “substantial owner” under section 1473(2), even if more than ten percent of the trust income is distributed to such person.
Proposed Reg. §1.1473-1(b)(3)(iii) goes on to state that in the case of a discretionary trust, where no beneficiary has a fixed entitlement to the income, the substantial United States owners” are to be determined annually, with reference to distributions actually made to the beneficiaries.  Example 2 in Proposed Reg. §1.1473-1(b)(7) is on point and instructive.
Proposed Reg. §1.1473-1(b)(3) provides workable “bright line” rules for determining whether a discretionary non-grantor trust has a substantial United States owner.  However, the Proposed Regulations abandon these bright-line rules for purposes of determining such a beneficiary’s interest in a corporation owned by the foreign discretionary non-grantor trust.  Consequently, under theProposed Regulations, a U.S. person may be treated as an owner of a corporation owned by a trust even when such individual is not treated as owning an interest in the trust which actually owns the shares of the corporation.  Proposed Reg. §1.1473-1(b)(2)(v) follows the “facts and circumstances” test in Treasury Reg. §1.958-1 to determine the beneficial owners of the stock of a corporation owned by a trust.  These rules are extremely difficult to apply in the case of a discretionary trust.  ACTEC submitted to representatives of the Department of the Treasury on June 23, 2010, a paper titled “Proposals for Guidance With Respect to the Coordination of the Foreign Corporation Anti-Deferral Rules and Subchapter J” (a copy of which is attached) suggesting a more workable solution to the problem of indirect ownership of foreign corporations held by foreign trusts.  Pending resolution of this issue, we recommend that the indirect owners of a corporation be determined in the same manner as ownership is determined with respect to the trust itself.
In short, with the minor suggested changes described above, we believe that the Proposed Regulations are sensible and workable in their application of the Section 1471 reporting responsibilities to FFIs that hold financial accounts for foreign trusts.  The FFI needs to obtain information on and report to the Internal Revenue Service each year, as “substantial United States owners” of a foreign trust, U.S. persons who received more than 10 percent of the distributions made from a foreign trust in the prior year.  This is the information that ACTEC understands Treasury needs to enforce the tax laws, in light of our discussion with Treasury last year, and the Proposed Regulations go about obtaining the information in a sensible way.  The difficulty with theProposed Regulations is not the manner in which they apply to FFIs holding financial accounts for foreign trusts, but how they apply to foreign trusts themselves if they are to be treated as FFIs.
B. Rules Applicable to Foreign Trusts if They Are to Be Treated as NFFEs
Non-financial foreign entities, or NFFEs, are defined in Section 1472 and theProposed Regulations thereunder.  Of course, while the statute and Proposed Regulations speak of withholding on payments made to the NFFE, if the assets of the NFFE are held in custody at an FFI, withholding could be done upon a payment made to the FFI as record owner for the account of the NFFE, or to the NFFE as beneficial owner.  We believe that if a foreign trust were treated as an NFFE, the Proposed Regulations under Section 1472 would be workable and would give the Treasury Department the information it needs for a foreign trust.
An NFFE is a foreign entity that is not a financial institution.  There are three types of NFFEs under the regulations—active NFFEs, excepted NFFEs, and passive NFFEs.  Proposed Reg. §1.1471-1.  An active NFFE is one subcategory of excepted NFFEs.  Other excepted categories include publicly traded corporations and their affiliates, entities owned by bona fide residents of a U.S. territory, and entities owned by exempt beneficial owners.
An active NFFE, which is one type of excepted NFFE, is defined as an NFFE less than 50 percent of the gross income of which in the preceding calendar year came from passive sources, or less than 50 percent of the value of whose assets in the preceding calendar year were assets that produce passive income.  Proposed Reg. §1.1472-1(c )(1)(v).  A passive NFFE is any NFFE that is not an excepted NFFE.  It seems likely that most foreign trusts would be treated as passive NFFEs, if they are to be treated as NFFEs under the Final Regulations.
A U.S. withholding agent must withhold 30 percent upon withholdable payments made to non-excepted NFFEs unless (i) the NFFE is the beneficial owner of the payment, (ii) the NFFE has provided the requisite documentation for the withholding agent to determine that it either has no substantial United States owner or has identified its substantial United States owners, and  (iii) the withholding agent agrees to report to the IRS by March 15 of each year the identity of the United States owners and any other information the United States may require.
There are significant differences between treating foreign trusts as NFFEs and treating them as FFIs.  In particular:
1. A foreign trust may satisfy the requirements of Section 1472 if it certifies to the withholding agent that it has no substantial United States owners.  Section 1472(b)(1)(A); Proposed Reg. §.1472-1(b)(1)(ii).  The majority of foreign trusts that are investing in the United States have no U.S. beneficiaries, and no U.S. relationship except that their trustees have chosen to invest in U.S. securities.  An FFI does not have the ability to certify to the U.S. withholding agent that it has no U.S. beneficiaries. An owner-documented FFI can certify that it has no U.S. owners only if it obtains an “auditor’s letter substitute,” as discussed below.  Therefore, if foreign trusts are to be treated as FFIs, rather than NFFEs, the trustee of a foreign trust with no U.S. beneficiaries has the choice of complying with onerous reporting obligations, including the giving of confidential information on foreign persons to the United States Treasury, or of not investing in the United States.
2. NFFEs may obtain a refund of taxes withheld under Section 1472, but FFIs may not obtain a refund of taxes withheld under Section 1471.  Section 1474(b)(2)(A)(ii) provides that in general, unless required by treaty, an FFI cannot obtain a refund of taxes withheld under Section 1471, if the FFI was the beneficial owner of the payment upon which taxes were withheld.  Section 1474(b)(2)(A)(ii); Proposed Reg. §1.1474-5(a)(2).  In the case of a trust, therefore, overwithheld taxes might be refunded if the income were distributed to a beneficiary currently, so that the trust was not the “beneficial owner” of the payments under the principles of Subchapter J, but a foreign trust that was treated as an FFI could not obtain a refund of taxes withheld under Section 1471 if the income was accumulated in the trust during the taxable year.  This harsh rule does not apply to NFFEs.
3. The “0 percent” substantial owner rule applicable to “Type iii” FFIs under Section 1473(2)(B) and Proposed Reg. §1.1473-1(b)(5) will apply to a foreign trust if it is treated as an FFI, but not if it is treated as an NFFE.  In practical effect, there is no difference between a “Type iii” FFI and a “passive NFFE,” but the rules applicable to passive NFFEs are workable for foreign trusts, while the rules for “Type iii” FFIs are not.  In this case, the sensible rules of Proposed Reg. §1.1473-1(b)(3)(iii) will not apply to a foreign trust if it is treated as an FFI, as discussed below.
C. Rules Applicable to Foreign Trusts if They Are to be Treated as FFIs
We believe that a foreign trust company will be treated as an FFI under Section 1471(d)(5)(A) and Proposed Reg. §1.1471-5(e)(1)(i), because it accepts deposits as part of its business.  Even if it does not accept deposits, under the Proposed Regulations an institution is treated as in a banking or similar business if it “holds itself out” as offering trust or fiduciary services, and thus is treated as an FFI.  The issue is whether a foreign trust will itself be treated as an FFI.  As noted above, we find several inferences in theProposed Regulations that foreign trusts are to be treated as FFIs, but no clear statement that in all cases they are to be so treated, with perhaps minor exceptions for small personal trusts.
If a foreign trust is to be treated as an FFI, it can avoid withholding upon payments of U.S. source income by becoming a participating FFI or a deemed-compliant FFI. 
In order to become a participating FFI, the foreign trust will have to enter into a participating FFI agreement with the Internal Revenue Service.  Proposed Reg. §1.1471-4.  In order to become a participating FFI,  a trust will have to agree to report  the name, address, and TIN of every U.S. account holder (with a “0 percent” threshold), and report the account balance of each U.S. account holder, as well as the interest, dividends, other income, and/or gross proceeds allocable to the account of each U.S. account holder.  This is not possible because beneficiaries of a discretionary trust in fact have no “accounts” within the trust,
Instead of agreeing to make such reports, which as a practical matter a trust could not do, a participating FFI may make an election under Proposed Reg. §1.1471-4(d)(5) to file information returns required under sections 6041, 6042, 6045, and 6049 as if it were a U.S. person.  This seems to be a very promising way to address compliance issues.  However, we suggest that the election be modified to allow an electing trust to agree to file the same forms that a U.S. trustee would file with respect to distributions to beneficiaries – namely, Forms K-1 – as required by Code §6034A (which is not one of the sections listed in theProposed Regulations).
Other than becoming a participating FFI, a foreign trust could also avoid withholding by becoming an “owner-documented FFI” under Proposed Reg. §1.1471-3(d)(7).  However, as written, the information required to be reported to the Treasury Department by an “owner-documented FFI” for a complex trust is far too extensive to be administrable.  If the foreign trust is a simple trust or a “grantor” trust owned by one or more taxpayers, the foreign trust treated as an FFI must supply the Service with name, address, taxpayer identification number, and account ownership information on each beneficiary or “grantor.”  But if the foreign trust is a complex, discretionary trust with multiple beneficiaries without fixed interests, in order to become an “owner-documented FFI” the trust must supply the IRS with name, address, taxpayer identification number, and account value information for every person, both U.S. and non-U.S., having an interest in the trust, with a “0 percent” threshold, thus requiring the trustee to give the IRS information on every possible beneficiary, U.S. or foreign, of the trust.  The statement to be provided to the withholding agent must set forth the percentage interest of each account holder in the trust, and of course they have no fixed or determinable interest.  And the statement must be annually updated.  If that is what the Final Regulations were to require, it would be an impossible task.
As an alternative to providing an FFI owner reporting statement, an owner-documented FFI may provide an “auditor’s letter substitute” from a U.S. auditor dated within one year of the payment, certifying that the auditor has reviewed the payee’s documentation with respect to all of its owners under the due diligence standard of Proposed Reg. §1.1471-4(c), the FFI qualifies to be an owner-documented FFI, and no direct or indirect owners are non-participating FFIs, U.S. persons, or passive NFFEs with any substantial U.S. owners.  This costly review is impractical.
D. Recommendations
If one applies the Proposed Regulations to a large discretionary trust, with individual or corporate trustees, that is a foreign trust with both U.S. and non-U.S. persons as eligible beneficiaries, the Proposed Regulations are administrable for the bank, custodian, or other FFI that holds the account of a foreign trust, and are also administrable for the trust itself if the foreign trust is to be treated as an NFFE. For these reasons, we recommend that the Final Regulations should clearly treat foreign trusts as NFFEs.  However, if for some reason Treasury believes that foreign trusts must be treated as FFIs, we submit that the Proposed Regulations are not administrable, and that it will be necessary to adopt specific provisions applying to discretionary trusts treated as FFIs.  We submit that the Final Regulations should do three things if they are to treat foreign trusts as FFIs :
1. They should provide that a foreign trust treated as an FFI should be able to be treated as a compliant FFI if it makes the certification provided for by Section 1472(b)(1)(A), for NFFEs, that it has no substantial United States owners.
2. They should recognize that discretionary trusts do not have “account holders” as such, and that the only account holder for a discretionary trust is a beneficiary who has actually received a distribution.
3. They should adopt the sensible and practical guideline of Proposed Reg. §1.1473-1(b)(3)(iii) that, in the case of a discretionary trust, an interest can be determined only by reference to the distributions actually made to the U.S. person in the preceding year.  The Proposed Regulation defines “substantial United States owner” for a discretionary trust by adopting a rule that such a person had to have received more than 10 percent of the amounts distributed by the trust in the prior calendar year.  Even if Treasury were to determine that it had an interest in applying the “0 percent” threshold for “Type iii” FFIs, and treated foreign trusts as such FFIs and subject to the “0 percent” threshold for withholding, we would urge Treasury to adopt a regulation, specific to discretionary trusts being treated as FFIs, recognizing that the only “accounts” they hold as an FFI are the amounts actually distributed to the beneficiaries in the prior calendar year.  Such a regulation could also provide that the trust must report to Treasury, as a “compliant” FFI, all amounts actually distributed by the trust to U.S. persons in the prior year, on a Form 3520-A, as modified by Regulation, or on a Form 1099.