Drew Hill, Senior Associate, Frost Brown Todd

Joe Dehner, Member, Frost Brown Todd

One of the many challenges facing companies that develop, utilize, or invest in digital assets (including cryptocurrencies, tokens, security tokens, and asset-backed digital assets) is navigating the complex legal and regulatory environment in the U.S. Digital assets do not fit neatly into the patchwork of securities, taxes, banking, and commodities laws, and yet, companies face severe penalties if they guess wrong about compliance requirements.

The decentralized nature of distributed ledger technology means that companies operating entirely outside the U.S. could still be subject to its laws. Take the case of the Foreign Account Tax Compliance Act (FATCA). FATCA is imposed on Foreign Financial Institutions (FFIs) that simply have custody of assets belonging to U.S. taxpayers.

Does FATCA also apply to digital assets? If so, companies may be required to register with the IRS and comply with FATCA or “opt out” by terminating all of their U.S.-taxpayer-customers.

What is FATCA?

FATCA imposes rigorous reporting, withholding, and compliance requirements on FFIs in order to deter and detect tax evasion by U.S. persons.

Generally, FFIs must (i) perform due diligence with respect to account holders, (ii) identify and report U.S. account holders to the IRS annually, (iii) obtain reporting waivers from each U.S. account, and (iv) withhold 30% on passthrough payments made to any U.S. accounts that have not granted the reporting waiver.

Non-U.S. entities that are not FFIs (NFFEs) must provide information regarding the identity of any U.S. persons having greater than 10% ownership of the entity.

Companies that fail to comply with FATCA are subject to 30% withholding on payments of certain U.S.-sourced income and the gross proceeds from the sale of debt or equity interests in U.S. issuers.

What is an FFI?

“Financial institution” is defined broadly to include banks; custodial institutions; investment entities (mutual funds, private equity funds, and hedge funds); any entity investing, administering, or managing financial assets on behalf of others; and specified insurance companies.

Companies should pay close attention to the definition of “custodial institutions,” which are “entities that hold financial assets for the benefit of one or more other persons as a substantial portion of their business.” Custodial institutions derive at least 20% of their gross income from any of the following activities:

  • Custody, account maintenance, and transfer fees;
  • Commissions and fees earned from executing and pricing securities transactions;
  • Income earned from extending credit to customers with respect to financial assets held in custody by the entity;
  • Income earned on the bid-ask spread of financial assets;
  • Fees for providing financial advice with respect to financial assets held (or to be held) in custody; and
  • Fees for clearance and settlement services.
What is an NFFE?

A NFFE is any non-U.S. entity that does not meet the definition of FFI, including entities such as listed or privately held operating or trading businesses, professional service firms, and charitable organizations. Publicly traded corporations are exempt.

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