[Federal Register Volume 78, Number 117 (Tuesday, June 18, 2013)]
[Notices]
[Pages 36616-36619]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-14418]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69741; File No. SR-DTC-2013-03]
Self-Regulatory Organizations; The Depository Trust Company;
Order Approving Proposed Rule Change in Connection With the
Implementation of The Foreign Account Tax Compliance Act (FATCA)
June 12, 2013.
On April 22, 2013, The Depository Trust Company (``DTC'') filed
with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-DTC-2013-03 pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder.\2\ The proposed rule change was published for comment in
the Federal Register on May 8, 2013.\3\ The Commission did not receive
comments on the proposed rule change. This order approves the proposed
rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 69494 (May 2, 2013), 78
FR 26823 (May 8, 2013) (SR-DTC-2013-03).
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I. Description
DTC is amending various DTC rules ``in connection with the
implementation of sections 1471 through 1474 of the Internal Revenue
Code of 1986, as amended, which sections were enacted as part of the
Foreign Account Tax Compliance Act, and the Treasury Regulations or
other official interpretations thereunder (collectively ``FATCA'').''
\4\ In its filing with the Commission, DTC provided information
concerning FATCA background, implementation, and DTC's proposed rule
changes.
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\4\ Id. at 26823.
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DTCC's Background Statement
FATCA was enacted on March 18, 2010, as part of the Hiring
Incentives to Restore Employment Act, and became effective, subject to
transition rules, on
[[Page 36617]]
January 1, 2013. The U.S. Treasury Department finalized and issued
various implementing regulations (``FATCA Regulations'') on January 17,
2013. FATCA generally requires foreign financial institutions
(``FFIs'') \5\ to become ``participating FFIs'' by entering into
agreements with the Internal Revenue Service (``IRS''). Under these
agreements, FFIs are required to report to the IRS information on U.S.
persons and entities that have (directly or indirectly) accounts with
these FFIs. If an FFI does not enter into such an agreement with the
IRS, FATCA will impose a 30% withholding tax on U.S.-source interest,
dividends and other periodic amounts paid to such ``nonparticipating
FFI'' (``Income Withholding''), as well as on the payment of gross
proceeds arising from the sale, maturity, or redemption of securities
or any instrument yielding U.S.-source interest and dividends (``Gross
Proceeds Withholding,'' and, together with Income Withholding, ``FATCA
Withholding''). The 30% FATCA Withholding taxes will apply to payments
made to a nonparticipating FFI acting in any capacity, including
payments made to a nonparticipating FFI that is not the beneficial
owner of the amount paid and acting only as a custodian or other
intermediary with respect to such payment. To the extent that U.S.-
source interest, dividend, and other periodic amount or gross proceeds
payments are due to a nonparticipating FFI in any capacity, a U.S.
payor, such as DTC, transmitting such payments to the nonparticipating
FFI will be liable to the IRS for any amounts of FATCA Withholding that
the U.S. payor should, but does not, withhold and remit to the IRS with
respect to those payments.
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\5\ According to DTC, non-U.S. financial institutions are
referred to as ``foreign financial institutions'' or ``FFIs'' in the
FATCA Regulations.
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According to DTC, as an alternative to FFIs entering into
individual agreements with the IRS, the U.S. Treasury Department
provided another means of complying with FATCA for FFIs which are
resident in jurisdictions that enter into intergovernmental agreements
(``IGA'') with the United States.\6\ Generally, such a foreign
jurisdiction (``FATCA Partner'') would pass laws to eliminate the
conflicts of law issues that would otherwise make it difficult for FFIs
in its jurisdiction to collect the information required under FATCA and
transfer this information, directly or indirectly, to the United
States. An FFI resident in a FATCA Partner jurisdiction would either
transmit FATCA reporting to its local competent tax authority, which in
turn would transmit the information to the IRS, or the FFI would be
authorized/required by FATCA Partner law to enter into an FFI agreement
and transmit FATCA reporting directly to the IRS. Under both IGA
models, payments to such FFIs would not be subject to FATCA Withholding
taxes so long as the FFI complies with the FATCA Partner's laws
mandated in the IGA.
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\6\ DTC states that as of the date of this proposed rule change
filing, the United Kingdom, Mexico, Ireland, Switzerland, Spain,
Norway, Denmark, Italy and Germany have signed or initialed an IGA
with the United States. The U.S. Treasury Department has announced
that it is engaged in negotiations with more than 50 countries and
jurisdictions regarding entering into an IGA.
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According to DTC, under the FATCA Regulations, (A) beginning
January 1, 2014, DTC will be required to do Income Withholding on any
payments made to any nonparticipating FFI approved for membership by
DTC as of such date or thereafter, (B) beginning July 1, 2014, DTC will
be required to do Income Withholding on any payments made to any
nonparticipating FFI approved for membership by DTC prior to January 1,
2014 and (C) beginning January 1, 2017, DTC will be required to do
Gross Proceeds Withholding on all nonparticipating FFIs, regardless
when any such FFI's membership was approved.
DTC stated that it already has established tax services that are
currently available to its Participants in which DTC, in accordance
with sections 1441 through 1446 of the Code, withholds on certain
payments of income made to certain of its Participants. Thus, DTC can
and intends to support certain FATCA Income Withholding as part of such
established tax services.
DTC's Statement on FATCA Implementation
According to DTC, in preparation for FATCA's implementation, FFIs
are being asked to identify their expected FATCA status as a condition
of continuing to do business. Customary legal agreements in the
financial services industry already contain provisions allocating the
risk of any FATCA Withholding tax that will need to be collected, and
requiring that, upon FATCA's effectiveness, foreign counterparties must
certify (and periodically recertify) their FATCA status using the
relevant tax forms that the IRS has announced it will provide.\7\
Advance disclosure by an FFI client or counterparty would permit a
withholding agent to readily determine whether it must, under FATCA,
withhold on payments it makes to the FFI. If an FFI fails to provide
appropriate compliance documentation to a withholding agent, such FFI
would be presumed to be a nonparticipating FFI and the withholding
agent will be obligated to withhold on certain payments.
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\7\ For example, credit agreements now routinely require foreign
lenders to agree to provide certifications of their FATCA status
under approved IRS forms to U.S. borrowers, and subscription
agreements for alternative investment funds that are anticipated to
earn U.S.-source income are routinely requiring similar covenants.
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DTC states that FATCA will require DTC to deduct FATCA Withholding
on payments to certain of its Participants arising from certain
transactions processed by DTC on behalf of such Participants.\8\
Because FATCA treats any entity holding financial assets for the
account of others as a ``financial institution,'' and almost all
Participants hold financial assets for the account of others, new and
existing Participants which are treated as non-U.S. entities for
federal income tax purposes, including those members and limited
members that are U.S. branches of non-U.S. entities (collectively,
``FFI Participants'') \9\ will likely be FFIs under FATCA. DTC says
that as a result, it will be liable to the IRS for the amounts
associated with any failures to withhold correctly under FATCA on
payments made to its FFI Participants.
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\8\ According to DTC, FFI participants resident in IGA
countries, that are compliant with the terms of applicable IGAs,
should not be subject to FATCA Withholding.
\9\ Currently, only a small percentage of DTC's Participants are
treated as non-U.S. entities for federal income tax purposes.
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In light of this, DTC has evaluated its existing systems and
services to determine whether and how it may comply with its FATCA
obligations. As a result of this evaluation, DTC has determined that
its existing systems are incapable of processing and accounting for
Gross Proceeds Withholding with regard to the securities transactions
processed by it, as no similar withholding obligation of this magnitude
has ever been imposed on it to date and DTC has therefore not built
systems to support such an obligation.
Additionally, DTC nets credits and debits per Participant for end
of day net funds settlement. There is further netting with DTC's
affiliated central counterparty, National Securities Clearing
Corporation and further netting on a settling bank basis; the effect of
this netting is to significantly reduce the number and magnitude of
payments made via the NSS System of the Federal Reserve. Gross Proceeds
Withholding would foreclose such netting, greatly reducing liquidity
available to the
[[Page 36618]]
system and Participants, increasing systemic risk.
Furthermore, DTC believes that, given DTC's netting, undertaking
Gross Proceeds Withholding could require DTC in certain circumstances
to apply its Participants Fund in order to fund FATCA Withholding taxes
with regard to nonparticipating FFI Participants in non-FATCA Partner
jurisdictions whenever the net credit owed to such FFI Participant is
less than the 30% FATCA tax. In the view of DTC, this would not be the
best application of such funds which are required to support liquidity
and satisfy losses attributable to the settlement activities of DTC,
inter alia. For example, if a nonparticipating FFI is owed a $100M
gross payment from the sale or maturity of U.S. securities, but such
nonparticipating FFI is in a net debit settlement position at the end
of that day because of DTC's end of day net crediting and debiting, and
the other netting described above, there would be no payment to this
FFI Participant from which DTC could withhold. In this example, DTC
would likely need to fund the $30M FATCA Withholding tax until such
time as the FFI Participant can reimburse DTC.\6\ In that case, DTC
would need to consider an increase in the amount of cash required to be
deposited into the Participants Fund, either by FFI Participants or all
Participants, which would reduce liquidity resources of Participants
and could have significant systemic effects. The amount of the FATCA
Gross Proceeds Withholding taxes would be removed from market
liquidity, which could lead to increased risk of Participant failure
and increased financial instability.
For the reasons explained above and the following additional
reasons, DTC is amending its rules to implement preventive measures
that would generally require all of DTC's FFI Participants not to cause
a Gross Proceeds Withholding obligation on DTC because DTC believes
that:
Undertaking Gross Proceeds Withholding by DTC (even if
possible) would make it economically discouraging for affected FFI
Participants to engage in transactions involving U.S. securities. It
would likely also quickly cause a significant negative impact on
liquidity because such withholding taxes would be imposed on the very
large gross amounts due to such FFI Participants. Furthermore,
Participants would be burdened with extra costs and the negative impact
on liquidity caused by the likely need to substantially increase the
amount of cash required to be deposited into the Participants Fund.
The cost of implementing a Gross Proceeds Withholding
system for a small number of nonparticipating FFI Participants would be
substantial and disproportionate to the related benefit. Under the
Model I IGA form and its executed versions with various FATCA Partners,
DTC would not be required to withhold with regard to FFI residents in
such FATCA Partner jurisdictions. Accordingly, DTC's withholding
obligations under FATCA would effectively be limited to
nonparticipating FFI Participants in non-FATCA Partner jurisdictions.
Since the cost of developing and maintaining a complex Gross Proceeds
Withholding system would be passed on to DTC's Participants at large,
it may burden Participants that otherwise comply with, or are not
subject to, FATCA Withholding.
As briefly noted above, absent this current action and in
order to avoid counterparty credit risk, DTC would likely require each
of the nonparticipating FFI Participants in non-FATCA Partner
jurisdictions to make initial or additional cash deposits to the
Participants Fund as liquidity for the approximate potential FATCA tax
liability of such nonparticipating FFI Participant or otherwise adjust
required deposits to the Participants Fund. The amount of such
deposits, which could amount to billions of dollars, would be removed
from market liquidity.
From the nonparticipating FFI Participant's perspective,
having 30% of its payments withheld and sent to the IRS would have a
severe negative impact on such nonparticipating FFI Participants'
financial stability. In most cases, the gross receipts are for client
accounts, and the nonparticipating FFI Participant would need to make
such accounts whole. Without receipt of full payment for its
dispositions, the nonparticipating FFI Participant would not have
sufficient assets to fund its client accounts.
These rule changes should not create an undue burden for
Participants because requiring FFIs to certify (and to periodically
recertify) their FATCA status, and imposing the costs of non-compliance
on them, are becoming standard market practice in the United States,
separate and apart from being a Participant of DTC.
Rule Changes
In line with its risk management focus, DTC has determined that
compliance with FATCA, so that DTC shall not be responsible for Gross
Proceeds Withholding, should be a general membership requirement (A)
for all applicants that are treated as non-U.S. entities for U.S.
federal income tax purposes, and (B) for all existing FFI
Participants.\10\ DTC is amending its rules as follows:
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\10\ DTC may grant a waiver under certain circumstances,
provided, however, that DTC will not grant a waiver if it causes DTC
to be obligated to withhold under FATCA on gross proceeds from the
sale or other disposition of any property.
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Amending Rule 1: adding ``FATCA,'' ``FATCA
Certification,'' ``FATCA Compliance Date,'' \11\ ``FATCA Compliant,''
and ``FFI Participant'' to Section 2 as terms cross-referenced from
Rule 2, Section 9;
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\11\ Although FATCA Withholding with regard to FFI Participants
approved for membership by DTC prior to January 1, 2014 is first
required under FATCA beginning July 1, 2014, the proposed amendments
to DTC rules would require such existing FFI Participants to be
FATCA compliant approximately 60 days prior to July 1, 2014 in order
for DTC to comply with its disciplinary and notice processes as set
forth in DTC rules.
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Amending Section 1 of Rule 2: adding the requirements
that, (i) with regard to any applicant that shall be an FFI
Participant, such applicant must be FATCA Compliant, and (ii) as a
qualification for activation of its membership that each applicant
approved by DTC complete and deliver to DTC a FATCA Certification; and
Adding new Section 9 of Rule 2: (i) Requiring all FFI
Participants (both new and existing) to agree not to conduct any
transaction or activity through DTC if such Participant is not FATCA
Compliant, (ii) requiring all FFI Participants to certify and, as
required under the timelines set forth under FATCA, periodically
recertify, to DTC, in accordance with the timelines set out under
FATCA, that they are FATCA Compliant, (iii) specifying that failure to
be FATCA Compliant creates a duty upon an FFI Member (both new and
existing) to inform DTC, (iv) providing that Participants that violate
the provisions of Section 9 are subject to disciplinary sanction or
other applicable actions by DTC in accordance with DTC rules,
including, but not limited to, a fine, as well as restrictions of
services to the Participant and/or ceasing to act for the Participant
in accordance with Rule 10, and (v) requiring all FFI Participants to
indemnify DTC for any losses sustained by DTC resulting from such FFI
Participants' failure to be FATCA Compliant. In addition, Rule 2,
Section 9 will include the definitions for ``FATCA,'' ``FATCA
Certification,'' ``FATCA Compliance Date,'' ``FATCA Compliant,'' and
``FFI Participant''.
In addition, DTC will modify its Policy Statement on the
Admission of Non-U.S. Entities as Direct Depository
[[Page 36619]]
Participants to reference DTC rules requirements of foreign entities
which are treated as non-U.S. entities for tax purposes.
II. Discussion
Section 19(b)(2)(C) of the Act \12\ directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Act and rules and regulations thereunder applicable
to such organization. Section 17A(b)(3)(F) of the Act \13\ requires the
rules of a clearing agency to be designed to, among other things,
promote the prompt and accurate clearance and settlement of securities
transactions, assure the safeguarding of securities and funds which are
in the custody or control of the clearing agency or for which it is
responsible, and protect investors and the public interest. The
Commission finds that DTC's proposed rule change is consistent with
these requirements because it is designed to comply with FATCA while
eliminating uncertainty in funds settlement. Specifically, based on
DTC's representations, the Commission understands that the proposed
rule change is designed codify DTC's rules in a way that will allow DTC
to comply with FACTA without developing and maintaining a complex Gross
Proceeds Withholding system under FATCA and, as a result, it will
eliminate uncertainty in funds settlement that DTC believes will arise
if DTC is subject to FATCA Withholding.\14\
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\12\ 15 U.S.C. 78s(b)(2)(C).
\13\ 12 U.S.C. 78q-1(b)(3)(F).
\14\ In approving this proposed rule change, the Commission is
mindful of the IRS's jurisdiction respecting FATCA. This Order does
not interpret FATCA. The Commission's approval of the proposed rule
change in no way constitutes a determination or finding by the
Commission that the proposed rule change complies with FATCA, which
is under the purview of the IRS.
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act and in
particular with the requirements of Section 17A of the Act \15\ and the
rules and regulations thereunder.
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\15\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-DTC-2013-03) be, and it hereby is,
approved.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-14418 Filed 6-17-13; 8:45 am]
BILLING CODE 8011-01-P