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(as opposed to an accountant or auditor) will allow the FFI to claim legal privilege in relation to information shared with that attorney, so any sensitive information disclosure can be managed appropriately. Such privilege could become important in protecting the FFI if, for instance, the FFI’s due diligence procedures uncover one or more rogue employees who have engaged in questionable activities. If the FFI chooses instead to engage an accountant who is not an attorney, communications between the FFI and the accountant will not be protected by legal privilege and may therefore be discoverable. NFFEs have a less onerous reporting and withholding regime. Like FFIs, they must report certain information to avoid 30 per cent withholding. However, unlike FFIs, NFFEs do not need to enter an agreement with the IRS to avoid withholding, but must simply give the withholding agent specifi ed information on any ‘substantial US owners’ or certify that they have no substantial US owners.

What about trusts?

The proposed regulations and notices did little to address the treatment of trusts and trust companies. The fi nal regulations provide some clarity while leaving other areas open to speculation.

Trust companies The fi nal regulations defi ne ‘fi nancial institution’ to include depository institutions that accept deposits in the ordinary course of a banking or similar business. Banking or similar business is defi ned to include providing fi duciary services to customers. Therefore, under the fi nal regulations, it seems that the IRS will treat non-US trust companies as FFIs. As such, every non-US trust company must decide whether to enter an FFI agreement or subject part of its income to a 30 per cent withholding tax.

Grantor trusts and estates

Under the FFI regime, an FFI that has entered an FFI agreement is obliged to report information regarding its US accounts. A US account is any fi nancial account maintained by an FFI that is held by one or more specifi ed US persons or US-owned foreign entities. The general rule for trusts is that the trust is the account holder. However, if the trust is a grantor trust, the trust is not treated as the account holder. Instead, the ‘owner’ of the grantor trust is treated as the account holder. Under the grantor trust rules, the owner is typically the individual who funds the trust. Therefore, an account held by a grantor trust with a non-US owner should not be categorised as a US account. As such, an FFI that holds an account of a non-US grantor trust with a non-US grantor should not be required to report the account even if there are US-person benefi ciaries. The fi nal regulations also provide that accounts

held by estates are excepted from the defi nition of a fi nancial account.

Non-grantor trusts: FFIs or NFFEs? The proposed regulations left unresolved whether non-grantor trusts would be treated as FFIs or NFFEs. The fi nal regulations attempt to resolve this issue, but many questions remain.


Under the fi nal regulations, FFIs are any non-US entities that fall into the categories of depository institutions, custodial institutions, investment entities

or insurance companies. A custodial institution is an entity that holds, as a substantial portion of its business, fi nancial assets for the benefi t of one or more other persons. An entity is deemed to hold fi nancial assets for the benefi t of others as a substantial portion of its business if the entity’s gross income attributable to holding fi nancial assets and related fi nancial services equals or exceeds 20 per cent of the entity’s gross income in the prior three years. Income attributable to holding fi nancial assets and related fi nancial services includes, but is not limited to, income generated from custody, account maintenance and transfer fees. Therefore, it seems that the IRS could categorise a trust as an FFI under the FFI custodial institution category. However, the IRS does not address this issue. Instead, the IRS implies in the preamble to the fi nal regulations that trusts will fall into the ‘investment entity’ category. An investment entity is defi ned broadly, but includes any entity that primarily conducts any of the following activities as a business on behalf of a customer: trading in certain fi nancial instruments; individual or collective portfolio management; or otherwise investing, administering or managing funds, money or fi nancial assets on behalf of others. An investment entity also includes any entity whose gross income is primarily attributable to investing, reinvesting or trading in fi nancial assets if the entity is managed by another FFI. An entity is managed by another FFI if the managing FFI performs, either directly or through another third-party service provider, any of the activities described above on behalf of the managed entity. An entity is treated as primarily conducting as a business one or more of the activities described above if the entity’s gross income attributable to such activity or activities equals or exceeds 50 per cent of the entity’s gross income during the three-year period ending on 31 December of the preceding year. The fi nal regulations provide the following examples for clarifi cation: • ‘Example 5. Trust managed by an individual. On January 1, 2013, X, an individual, establishes Trust A, a non-grantor foreign trust for the benefi t of X’s children, Y and Z. X appoints Trustee A, an individual,

APRIL 2013 69

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