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February 2013 FATCA insurance alert Final FATCA regulationsGet the facts on FATCA! refine definitions and provideYou can access currentFATCA news and some relief for requirementsthought leadership. specific to insurance companiesType into your web browser:www.ey.com/FATCA Executive summary In the final FATCA regulations, the US Treasury and the Internal Revenue Service (IRS) adopted a significant number of changes that impact insurance companies. Many of these comeintoeffect on1 January 2014. Of the changes, four stand out as having the greatest impact across all segmentsofthe insurance industry: • A new de minimis rule to exclude from the definition of a financial account any insurance contract, other than an annuity, with cash value of less than US$50,000 at all times during the year • Insurance-related definitions were simplified to replace most references to US tax law with plain language descriptions and, where appropriate, references to local law treatment • Changes to the definition of cash value insurance contracts to add additional exemptions to reduce the number of insurance contracts treated as financial accounts • Insurance companies paying death benefits are no longer required to obtain documentation on a beneficiary (other than the owner), unless the insurance company has actual knowledge or reason to know that the beneficiary is a US person
Background These four changes, alongOn 17 January 2013, the US Treasury and the IRS with a number of otherreleased the long-awaited final regulations under theForeign Account Tax Compliance Act (FATCA), changes, are summarizedprovisions of Sections 1471–1474 (also referred to asthe “chapter 4” provisions) of the Hiring Incentives to in the following discussion:Restore Employment (HIRE) Act (P.L. 111-147). (SeeTax alert 2010-467.) The final regulations reflectcomments received from a number of financial Key changesinstitutions, including insurance companies, tradeorganizations, foreign governments and other Changes in scopestakeholders, regarding the proposed regulations, With some notable exceptions, the FATCA regulations have beenwhich were published in the Federal Register on modified to introduce new de minimis thresholds and narrow the15 February 2012. The final regulations are in excess types of insurance contracts and business activities of insuranceof 540 pages and incorporate many of the provisions companies that are in scope, all of which will reduce the numberreflected in the intergovernmental agreements of companies, accounts and customers impacted by FATCA.(IGAs) that have been signed by the US and foreign Certain insurance and annuity accounts are no longergovernments on FATCA compliance. (See Tax alerts considered financial accounts subject to FATCA due diligence,2010-1164, 2011-662, 2011-1185, 2012-310 and reporting and withholding:Insurance alert CK0507.) • Cash value insurance contracts with a value of less thanThe final regulations attempt to limit the institutions, US$50,000 at any time during the calendar year. As a result,obligations and accounts subject to FATCA to more most property and casualty, disability, accident and health,specifically target high-risk financial accounts and other non-cash value insurance that contains contractualand address practical operational considerations. features, such as return of premium, should fall outside theTo address the many comments they received, the definition of a financial account. This de minimis thresholdTreasury and the IRS established three avenues for should also cause many cash value insurance products inaddressing the principal concerns regarding costs emerging markets and offerings in lower cash value insuranceand burdens associated with implementing FATCA lines of business to be out of scope.and the legal impediments to compliance in a numberof jurisdictions: • Indemnity reinsurance agreements are now specifically excluded from the definition of a financial account under FATCA.• Adopted a risk-based approach to implementingthe statute to address policy considerations • Certain immediate annuities that monetize retirement oreffectively and eliminate unnecessary burdens pension accounts using non-investment linked, non-transferable immediate life annuities are no longer considered financial• Collaborated with foreign governments to develop accounts subject to FATCA.IGAs that remove legal impediments • Term life insurance contracts with increasing premiums are• Developed administrative approaches to simplify no longer financial accounts if coverage ends before age 90,the process for registering and entering into an premiums do not decrease over time and there is no cash valueagreement with the IRS to minimize costs associated payable without terminating the contract. It appears this newwith compliance definition should resolve the issue regarding non-forfeitureThis alert provides an executive summary of key benefits on level premium term life insurance contracts.provisions in the final regulations that apply The definition of retirement and pension accounts has beenspecifically to insurance companies. The final modified so that more foreign plans and products are eligible for theregulations contain numerous rules that have broad exclusion from FATCA, although the reporting requirements forapplication to all financial institutions and many of pension plans have been broadened. In many cases, retirementthese provisions are discussed in Tax Alert 2013-165. and pension accounts will be excluded via Annex II of IGAs.In the coming weeks, we will publish alerts to providemore in-depth explanation of the broader rules Insurance companies that have elected to be treated as a USapplicable to all financial institutions, with specific insurance company for federal income tax purposes underfocus on the rules directed at insurance companies Section 953(d), are considered foreign financial institutionsand their products. (FFIs) unless they are licensed to do business in the US. Since most Section 953(d) companies are not licensed in the US, this2
provision will treat them as a foreign insurance company for cancelation or withdrawal or that can be borrowed under or withFATCA reporting purposes, even though they file a US income tax regard to the contract. Cash value is a key factor in determiningreturn. However, Section 953(d) companies, along with other if an insurance contract is to be treated as a cash value insuranceFFIs, may elect to report FATCA information in a manner similar contract under FATCA. The exclusions from cash value wereto a US withholding agent using IRS Form 1099-R. modified to specifically exclude a death benefit payable under a life insurance contract, a refund of previously paid premiums due toLife insurance contracts purchased by a transferee for value termination of the contract and a return of an advance premium orwill be treated as financial accounts subject to FATCA. premium deposit when the premium is payable at least annually ifA “local FFI” exemption is now available to insurance the amount held does not exceed the next annual premium payablecompanies. The deemed-compliant rules have been expanded under the contract. However, policyholder dividends for term lifeto allow insurers to qualify as local FFIs and FFIs with only insurance contracts are no longer excluded.low-value accounts. There are significant restrictions on the use These changes should go a long way in helping insuranceof this deemed-compliant status, including a requirement that all companies exclude a number of insurance contracts (other thanmembers of the expanded affiliate group do not have a place of annuity contracts), which are otherwise considered cash valuebusiness outside of a single country (other than administrative products, from treatment as a financial account. Under theactivities). It is not likely this will be of use to large insurance proposed regulation rules, in many cases, these contracts metgroups, but it may provide limited market advantage to small, the “technical definition” of cash value and were consideredlocal or web-based competitors. However, these entities will still financial accounts. This modification is welcome.be required to perform a number of FATCA activities. The depository account definition has been refined to includeChanges in definitions certain typesof accounts offered by life insurance companies such as a guaranteed investment contract or similar agreements to payFATCA definitions impacting insurance companies have been or credit interest on amounts held with the company. Under thesimplified and clarified, making the regulations easier to proposed regulations, any amount held at interest byunderstand. That being said, the definitions still leave room a life insurance company was considered a depository account.for interpretation and judgment, and may prove difficult to In addition, a new exception is provided to remove advanceimplement consistently for global organizations. premiums or premium deposit funds from the definition of aThe definitions of “life insurance contracts,” “annuity contracts” depository account. These changes should help to reduce theand “insurance companies” have been simplified and are now number of accounts held by life insurance companies that maybased on plain-language definitions with references to local law, be classified as a depository account and, thus, reduce thewhen appropriate, instead of by reference to US tax law. This number of financial accounts.should ease the understanding of FATCA for those with less The various rules relating to the aggregation of financial accounts inunderstanding of US tax laws. Chapter 4 have now been coordinated to provide that, whenNew definitions are provided for “group annuity contract,” “group aggregation is required, it applies to all financial accounts heldinsurance contract,” “immediate annuity,” “deferred annuity,” by the FFI and any other member of the expanded affiliated“investment-linked annuity contract,” “investment-linked group. However, this is only to the extent that computerizedinsurance contract,” “life annuity contract” and, in some cases, systems link the accounts by reference to a data element such asclarify the treatment of these contracts as financial accounts. a client number, EIN or foreign tax identifying number, and allow the account balances to be aggregated. It is helpful that the sameThe cash value definition is modified to mean any amount that is standard is now applied whenever aggregation is required to helppayable under a contract to a person upon surrender, termination, ease the administrative burden of applying these rules.FATCA insurance alert 3
Aggregation is also required for accounts that a relationship manager knows are directly or indirectly owned or controlled by the same person or that the relationship manager has associated with each other by an indicator, or for other business purposes. Further, if the company chooses to treat the accounts of an account holder as one obligation (i.e., as consolidated obligations) in order to share information between them or to permit the treatment of new accounts of pre-existing account holders as pre- existing accounts, these accounts must also be aggregated. See also, the discussion of the treatment of new accounts of pre- existing account holders on p5. The investment entity definition was broadened to include asset managers and investment advisors. The broadening of the definition of investment entities means that asset managers and any entity that invests funds for customers will be FFIs. Other provisions in the final regulations allow asset managers that manage funds of various sorts to be “sponsoring entities” and to register with the IRS to take on the participating foreign financial institutions (PFFIs) responsibilities for these funds. The funds are then sponsored entities. This approach is consistent with how asset management companies actually operate and could reduce their compliance burden. The grandfathered life insurance and annuity contracts definition for purposes of exclusion from FATCA withholding has been broadened to include all life insurance contracts (and payment on those contracts) payable no later than the death of the insured and existing immediate annuity contracts that are payable for a certain period or the life of the annuitant. This provision applies to contracts outstanding prior to 1 January 2014 and should allow for the grandfathering of most life insurance and immediate annuities.4
Account holder due diligence and reporting of The definition of who is the holder of a financial account isfinancial accounts expanded, requiring documentation of additional individualsThe final regulations provide greater clarity on the obligations in some cases. Insurance or annuity contracts treated asand required documentation for account holder due diligence, financial accounts are considered held by each person whowhile reducing due diligence for certain types of accounts and can access the contract value (loan, withdrawal or surrender)updating FATCA documentation and reporting deadlines. or change the beneficiary. If no person can access the contract value or change a beneficiary, then the account is treated asDocumentation of life insurance beneficiaries is reduced. held by both the person named in the contract as the ownerAn individual beneficiary receiving a benefit under a cash and each beneficiary. When the obligation to pay an amountvalue life insurance contract, other than the owner, is presumed under the contract becomes fixed, each person entitled toto be a foreign person unless US indicia are present, or the payment is treated as a holder of the account.company knows or has other reason to know the individualis a US person. Thus, most beneficiaries will not require duediligence or documentation. This new provision applies only Election to report in manner similar to US lifeto policies issued by FFIs. Under the proposed regulations, a insurance companiesbeneficiary receiving death benefits is an account holder of FFIs may elect to report their insurance and annuity contracts in aa financial account. However, due to this presumption, the FFI manner similar to the reporting that US life insurance companiesis not required to document the beneficiary unless it knows or follow for domestic contracts. This election may allow some lifehas reason to know that the beneficiary is a US person. insurance companies to use systems and procedures already in place at US-affiliated companies and centralize some of theCertain group life insurance and group annuity contracts will compliance process.not require documentation until the payment to individualparticipants. Group accounts will be treated as non-US Treating new accounts as pre-existing accounts allows for limitedaccounts until the date on which an amount is payable to an additional documentation. “Consolidated accounts” is a new optionemployee or certificate holder or beneficiary, if the insurer that FFIs can elect to apply for treating new contracts related toobtains a certification from an employer that no employee or existing customers as pre-existing contracts. In order to qualify,certificate holder is a US person. The group must cover 25 the contracts must meet certain aggregation and reason- to-knowor more employees or certificate holders, all contract values rules with regard to the new contract and any pre-existing contracts.must be payable to employees or certificate holders and theemployees or certificate holders must be entitled to name The valuation date for insurance and annuity contracts is thebeneficiaries for the death benefits payable and the aggregate year-end or most recent anniversary date, depending upon howamount payable to any employee or certificate holder or the company reports information to its account holders. Forbeneficiary cannot exceed US$1m. immediate annuities without a minimum benefit and the value of which is not reported to the account holders, the value toGrandfathering of policies is extended to 1 January 2014 be reported is the net present value, with adjustments usingand grandfathered accounts below a de minimis threshold assumptions to be provided by the IRS.will not require documentation. An FFI is not required toperform identification and documentation procedures for cash Form 8966 FATCA is the new form the IRS will release for FFIsvalue insurance or annuity contracts with a cash value less to report information regarding their financial accounts.than US$250,000 and which was in effect as of1 January 2014 (pre-existing contracts) for individual or entityaccounts. The exception for each contract will cease at the endof any subsequent calendar year in which the account balanceor value exceeds US$1m. Certain aggregation rules may applyin determining the balance or value.FATCA insurance alert 5
Withholding and withholdable payments? identified as withholdable payments. (Treasury noted in theKey aspects of withholding have been deferred, and in preamble that it did not find the application of Section 4371conjunction with IGA agreements, fewer transactions are excise tax a compelling argument to exclude premiumexpected to be subject to withholding. Withholding for cash payments from FATCA.) This means that many US insurancevalue life insurance and annuities has been simplified to treat all companies that do not issue cash value insurance or annuitypayments as withholdable, regardless of their US tax treatment. contracts that are treated as financial accounts are likely still toThe scope of withholdable payments has been refined have some obligations to apply the withholdable paymentto include insurance and reinsurance premium payments rules to transactions with foreign counterparties, brokersand the definition of non-financial payments, which are and reinsurers.excluded from the withholdable payment.Gross proceeds withholding has been deferred to 2017.Gross proceeds from the sale of securities that produce interestor dividends are treated as withholdable payments; however,the requirement for withholding has now been delayed untilat least 2017.Any distribution (including redemption) made to an accountholder with respect to a cash value life insurance or annuitycontract must be reported as a withholdable payment,regardless of its US tax treatment. In other words, death benefitpayments, policyholder dividends, etc., must be treated aswithholdable payments even though they may not be taxableincome to the recipient.The grandfathered obligations definition has been expandedto include life insurance contracts in effect on 1 January 2014,which are payable no later than upon death of the insurance,including endowment benefits and immediate annuities forlife. These modifications should exempt a large percentageof existing life insurance and immediate annuities currentlyin force from future withholding under FATCA; however, thecontracts are still subject to the identification and reportingrequirements highlighted above. Moreover, a premium paidwith respect to a grandfathered obligation is treated asa payment made under a grandfathered obligation and istherefore grandfathered.The withholdable payments definition has been refined toidentify what are excluded non-financial payments and what areincluded payments. It is thought that “included payments”must have a US source to be considered withholdable, butthis is not completely clear from the final regulations. Insurancepremiums and reinsurance premiums on all contracts andamounts paid under cash value insurance and annuitycontracts (presumably if otherwise US source) are specifically6
Implications and finalobservationsThe final FATCA regulations contain many importantand helpful changes that should allow insurancecompanies to simplify their documentation andimplementation processes; however, even with thesechanges, the FATCA rules are complex and there arestill many unanswered questions. FATCA will impact theinformation gathered from clients and distributionchannels and require changes to client onboarding andmonitoring processes in all geographies. As companiesmove forward with their compliance efforts, care shouldbe taken to understand and comprehend fully thenumerous provisions of the final regulations andhow they impact specific insurance products andinsurance companies. The results are not alwaysintuitive or logical. “The complexity will carry over to the insurancecompany’s communications plan to employees, agentsand brokers to train them on the administrative andsystems changes required by FATCA and the impact topolicyholders.” This complexity is now more real thanever. While we now have the final regulations, thecomplex and time-consuming tasks of implementingthe necessary changes, mitigating the impact oncustomers and complying with FATCA in a practicaland efficient manner are still ahead. The FATCAstatute and the new final regulations are complex andwill require ongoing analysis to understand andmitigate the impacts on customers, business activitiesand operational costs.We will be issuing additional guidance in the comingweeks to provide a more in-depth discussion of thesenew provisions, as well as analysis of the operationalimplications of these changes on the insurance industry.In the meantime, we encourage you to reach out toyour Ernst & Young advisor for further information.FATCA insurance alert 7