[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