Law firm Withers says the Hiring Incentives to Restore Employment Act of 2010 may be the broadest tax and information reporting legislation ever enacted, potentially affecting all investors and virtually all non-US banks, investment houses, brokerages, custody agents, mutual funds, hedge funds, private equity funds and life insurance providers with any investments in the US.

The Hire Act, enacted this past March, left a number of issues to be determined at the discretion of the IRS and the US Treasury.

Since its enactment, US and non-US investors and the non-US financial institutions and funds through which they invest have speculated as to whether regulations would be issued to limit the broad impact of this client identification legislation, and what these limitations and exceptions might be. 

On its face, the Hire Act requires any entity classified as a foreign financial institution to either enter into an arrangement by which the FFI agrees to determine which of its account holders are US citizens, green card holders or tax residents, or entities which are substantially owned by US persons, or suffer 30 per cent gross withholding on all amounts invested into the US.

The withholding would apply to virtually all amounts invested by the FFI into the US, whether for its own account or for the account of its account holders, regardless of whether or not they were US persons.

Earlier this week, the IRS issued the first formal guidance on certain priority issues relating to these new provisions.

The notice confirms that non-US trust companies are classified as FFIs, just like banks, financial institutions and brokerages. Thus, absent a special exemption being issued in future guidance, any trust company not signing up to an FFI agreement would suffer 30 per cent withholding on virtually all investments into the US with respect to any and all trusts for which they serve as trustee.

The notice also implies, but does not specifically state, that individual trusts themselves would be classified as FFIs; though it also suggests that small family trusts might be exempted from this classification, according to Withers.

If accurate, each individual trust with US investments would have to enter into an FFI agreement in order to avoid 30 per cent withholding on those investments. In the view of Withers, such treatment would be completely unnecessary to facilitate the goals of the Hire Act and would be overly burdensome on the individual trusts and the IRS. It also would render meaningless certain other related provisions of the legislation with respect to determining beneficial ownership of trust structures.

The fund industry has submitted detailed comments to the Treasury and IRS indicating that in many instances funds themselves prohibit sale to US investors.

The notice indicates that consideration is being given to whether these procedures might form the basis for exempting funds from FFI related requirements. However, comments have specifically been requested as to whether these US investor restrictions meet the definition of a US person as set out for US tax purposes, the extent of KYC/AML due diligence required, as well as whether any such restrictions would limit investment in such funds by non-participating FFIs.

Although it remains a possibility that certain funds ultimately may be exempted, the notice implicitly suggests that the local regulatory regime applicable to the fund would need to impose comprehensive due diligence requirements with respect to determining whether any direct or indirect owners are US persons before the IRS would consider implementing any such exception.

The following entities will be exempt from the FFI regime, and will also be exempt from US withholding under the parallel regime applicable to certain non-financial foreign entities: (i) certain holding companies for non-financial enterprises (but not an entity functioning as an investment fund); (ii) start-up companies (other than financial institutions) for the first 24 months after their organisation; (iii) non-financial entities liquidating or emerging from bankruptcy or reorganisation; (iv) hedging/financing centres of a non-financial corporate group.

The withholding obligations under the Hire Act will take effect from 1 January 2013, but FFIs wishing to enter into client identification agreements will need to act immediately to begin the process of implementing account holder identification processes.