CONTINUEThis site uses cookies. By continuing to browse this site you are agreeing to our use of cookies. Find out more.
  1. Front Page
  2. Features
  3. Global Tax Topical Focus - FATCA Is Coming

Global Tax Topical Focus - FATCA Is Coming

By Editorial
May 22, 2012

The Foreign Account Tax Compliance Act is seen by some as a necessary tool to combat unacceptable tax avoidance by US citizens placing money in foreign bank accounts at a time when more 'patriotic' taxpayers are paying their fair share towards reducing the federal deficit, and by others as an unlawful incursion by the US government into the legal affairs of sovereign states and another nail in the coffin of individual privacy. Like it or not, however, FATCA, as it is more popularly known, is here to stay.

While FATCA may not have occupied the thoughts of the average US taxpayer over the past couple years - indeed, it is only likely to affect a relatively small percentage of the US population - the fact is that this far-reaching piece of legislation will have implications not only for US investors with interests abroad, but also for banks and other foreign financial institutions all over the globe which deal with US clients.

FATCA was enacted by the US in March 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act and is intended to ensure that the US tax authorities obtain information on financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest, at foreign financial institutions (FFIs). Failure by an FFI to disclose information would result in a requirement to withhold 30% tax on US-source income.

Under the legislation, a participating FFI will have to enter into an agreement with the US Internal Revenue Service (IRS) to provide the name, address and taxpayer identification number (TIN) of each account holder who is a specified US person; and, in the case of any account holder which is a US-owned foreign entity, the name, address, and TIN of each substantial US owner of such entity. The account number is also required to be provided, together with the account balance or value, and the gross receipts and gross withdrawals or payments from the account.  

These provisions are generally effective for payments made after December 31, 2013, and apply to any US resident who holds more than USD50,000 in a depository or custodial account maintained by an FFI, but FFIs have until June 30, 2013, to enter into agreements with the IRS to ensure that it will be identified as a participating FFI in sufficient time to allow withholding agents to refrain from withholding beginning on January 1, 2014. Withholding on US source dividends and interest paid to non-participating FFIs will begin on January 1, 2014, and will be fully phased in on January 1, 2015. Due diligence requirements for identifying new and pre-existing US accounts (including certain high-risk accounts, including private banking accounts with a balance that is equal to or greater than USD500,000) will begin in 2013, and reporting requirements will begin in 2014.

Commenting on the legislation recently, Acting Assistant Secretary for Tax Policy, Emily S. McMahon said: “When taxpayers overseas avoid paying what they owe, other Americans have to bear a disproportionate share of the tax burden”. So, therefore, according to McMahon: “FATCA is an important part of the US government’s effort to address that issue, and these regulations implement FATCA in a way that is targeted and efficient. We believe these efforts will serve as a complement and catalyst to the ongoing global efforts to combat offshore tax evasion.”

However, FATCA has provoked an outcry from many quarters, particularly certain foreign governments and the financial services industry, who have complained that the legislation effectively turns non-US banks into an extension of the IRS.

Canada has been especially vocal on the subject, with Finance Minister Jim Flaherty going as far as writing an open letter to several US publications last year to assert that Canada was no ‘tax haven’ and that FATCA would swamp Canadian taxpayers in red tape and accomplish little. He was clear that "people do not flock to Canada to avoid paying taxes", and that, with a tax information exchange agreement already in place, there is an existing way of addressing tax issues. There is, therefore, already a system that works, he argued. As a result, Flaherty was clear that "to rigidly impose FATCA on our citizens and financial institutions would not accomplish anything except waste resources on all sides".

Even the European Union, certainly no stranger to extra-territorial rule-making with its Savings Tax Directive, has used official channels to express concern over the widespread impact of FATCA.

In a letter sent last year to the United States Treasury Secretary, Timothy Geithner, and the Internal Revenue Service Commissioner, Douglas Shulman, the European Council and the European Commission pointed out the potential negative effects that FATCA would have on the European financial services industry. The letter from then Chair of the European Economic and Financial Affairs Council, Hungarian Finance Minister György Matolcsy, and the European Commissioner in charge of Taxation Algirdas Šemeta, invited the US tax authorities to engage in a dialogue on how to best achieve FATCA’s objectives. In this regard, it was pointed out that FATCA's goals are similar to those of the EU Savings Tax Directive. which provides for an exchange of information between tax authorities of EU member states, and that the information exchange tools that already exist between tax administrations should be utilised for the purposes that FATCA is seeking to address.

Predictably, EU financial institutions (including banks, investment funds and insurance companies) have also expressed concern about the legislation, in particular the costs of compliance and penalties that will ensue in case of non-compliance. The European financial industry has estimated that the costs of modifying their IT systems, and the administrative burden of ensuring compliance with FATCA, would be significant. While no official estimate of these costs exists, it is thought to be in the billions of dollars. Indeed, KPMG has predicted that FATCA will cost the industry much more than it is likely to raise for the IRS.

For all the indignation and hostility to FATCA from the financial services industry however, it seems that foreign governments are coming round to the fact that the best way to deal with the problem is to cooperate with the US to ensure that the new rules operate as smoothly as possible, rather than oppose it outright. This was demonstrated in February, when, as part of proposed regulations for the next phase of FATCA implementation, five EU countries, including France, Germany, Italy, Spain and the United Kingdom, issued a joint statement with the US on a possible government-to-government framework for information exchange. This is being seen an important step toward addressing legal impediments to FFIs’ ability to comply with the regulations.

The statement does not contemplate an exemption from FATCA for any jurisdiction, but instead offers a framework for information sharing based on existing bilateral tax treaties and allows FFIs to report the necessary information to their respective governments rather than to the IRS. In that regard, the US is also willing to reciprocate in collecting and exchanging, on an automatic basis, information on accounts held in US FIs by residents of France, Germany, Italy, Spain and the UK.

Other nations are expected to join this accord in due course, including Ireland, which, according to the Irish Funds Industry Association (IFIA), is in contact with the US Treasury, with discussions ongoing. As the IFIA has pointed out, Ireland is negotiating the possible adoption of a model global agreement, which would not alter or amend the obligation to identify or report certain information under FATCA, but would outline an alternative pathway for reporting FATCA information. The IFIA expects this agreement to be concluded by the end of the year. Ken Owens, Chairperson of the IFIA, explained: "The fact inter-governmental arrangements are likely to be based on a model agreement means that any framework under which bilateral exchange of information agreements operate should be done on a consistent basis, rather than under individual agreements which might be operated on a disjointed basis. This is welcome news for an industry which operates on a multi-jurisdictional basis.”

Offshore financial centres are also having to take notice of the FATCA threat, given the importance of banking and other financial services to these economies. The Isle of Man government has announced that it may work with a number of other countries, including the UK, in order to help reduce the compliance burden of FATCA on the jurisdiction's financial services industry. Manx Treasury Minister Eddie Teare said: “FATCA is a piece of legislation likely to have profound implications for global tax co-operation. I am committed to ensuring that we provide the best possible environment for business in the Isle of Man, and how we deal with FATCA as a government is vital to the business environment. I also feel that we face almost identical issues in relation to FATCA as Guernsey and Jersey, and I have asked the working party to contact and work going forward with their counterparts in the Channel Islands.”

The proposed regulations issued in February will reduce the administrative burdens associated with identifying US accounts by calibrating due diligence requirements based on the value and risk profile of the account, and by permitting FFIs in many cases to rely on information they already collect, including information received to comply with anti-money laundering (“know your customer”) rules. They will also expand the categories of FFIs that are deemed to comply with FATCA without the need to enter into an agreement with the IRS, in order to focus the application of FATCA on higher-risk FFIs that provide services to the global investment community, and phase-in the reporting and withholding obligations of FATCA over an extended transition period to provide sufficient lead time for FFIs to develop necessary systems.

However, while the proposed new regulations appear to take on board much of the criticism aimed at the original legislation, and may help to mitigate the impact of FATCA on FFIs and national tax administrations, they have still elicited a mixed response. The insurance industry will benefit from the new regulations on the one hand because they have clarified what sorts of insurance products will fall under the new law. But on the other hand many products remain within the scope of the legislation, meaning that companies in the industry will still need to be aware of the possible consequences of FATCA and plan for them.

As Rob Lant, insurance tax partner at KPMG in the UK observed: “The FATCA challenge will remain a significant and complex one for the insurance industry with many products still within scope, however there are nevertheless reasons to be positive. Buried within the 389 pages of draft rules is some good news for insurers which will translate into cost savings for the industry. We estimate the global insurance industry has saved close to USD3bn due to the IRS tightening the scope of FATCA and making the proposals more proportionate. The good news includes that UK insurers should be deemed compliant foreign financial institutions (FFIs) if an agreement is reached between the UK and US governments as indicated in their joint statement. Also, writing certain policies will be excluded from triggering FFI status, including property and casualty insurance, regular premium term assurance, personal pensions and PHI products. For new accounts, it should be possible to place more reliance on existing know your customer (KYC) and anti-money laundering (AML) procedures. And the required due diligence for in-force policies, which needs to be completed within one year or two years of July 1, 2013, will be less onerous for policies with lower cash values. For those policies worth USD250,000 or less there is a complete exception, while cash values from USD250,001 to USD1m will only require an electronic search for US indicia; and ‘passthru’ payments will only be within the regime from January 1 2017."

However, Lant also points to the problems the rules will raise. He said: "Firstly there is no specific exclusion for smaller UK industry players, such as friendly societies, although the exclusions for back book due diligence should help. Secondly, for any legal entity that writes cash value insurance products FFI withholding and reporting potentially applies to all other policies written including any property and casualty insurance, regular premium term assurance, personal pensions and PHI products. The bottom line is FATCA has not gone away for insurance groups and the focus should now shift to preparing for the commencement of the regime. Preparing means determining which entities in your group are FFIs and having suitable procedures in place to identify US account holders for policies written on or after 1 July 2013. It also means performing a due diligence exercise on policies in-force over the two year period after the effective date of your FFI agreement, although the graduated requirements (and exclusions) based on the cash values of policies should make this significantly less burdensome.”

While we have noted the extra administrative burden that FATCA will place on firms in the financial services industry, perhaps the largest single burden will fall on the IRS itself, which must collect, collate and analyse the data it receives from the hundreds of thousands of FFIs expected to take part in the scheme, as well as enforce the new law. And this at a time when it is playing a key role in implementing and managing President Obama’s health care law in addition to its normal role of administering America’s hugely complex tax code.

These concerns were touched upon in a report ordered by Congress into how the IRS intends to implement FATCA and use the information it receives under the law, and which was published last month.

According to the Government Accountability Office, which conducted the review, the IRS has taken initial steps to implement FATCA requirements in line with normal implementation practices, including establishing a team to manage the implementation process and issuing guidance and proposed regulations, and it has also involved external stakeholders in the implementation process. The IRS has also communicated initial information to its staff. However, although the IRS assessed the risks of some aspects of FATCA implementation, it has not consolidated existing risk assessment information or future risk assessment plans into an overall risk assessment. Without a consolidated assessment, the GAO noted, there is less assurance that all risks have been comprehensively identified.

In addition, the GAO has found out that the IRS plans to compare multiple sources of information to identify US taxpayers and FFIs failing to comply with the FATCA requirements and, more broadly, taxpayers failing to report their overseas income. However, while the IRS has begun to discuss how it will use information to improve compliance, it has not yet completed or fully documented a broader strategy for doing so. For example, it has not developed key internal milestones for accomplishing the tasks necessary to enable it to use FATCA information to improve taxpayer compliance or performance measures to assess the cost and benefits of its compliance efforts. Nor, it is said, has the IRS developed a comprehensive resource estimate for FATCA implementation. Without a timeline to develop the estimate, the GAO concludes, the IRS may not be able to develop a reliable cost estimate and therefore risks not communicating key cost information to Congress and IRS management in time for them to make decisions affecting the implementation of FATCA.

But despite all the concerns, the FATCA train is rumbling relentlessly onwards, and is likely to remain on track unless Congress suddenly decides to repeal the legislation (which would appear extremely unlikely in the short-term at least). However, while the US government continues to justify the legislation in terms of ‘fairness’, - i.e. why should wealthy investors be allowed to squirrel away their earnings offshore while the hard-pressed middle classes shoulder the tax burden? – it is felt that could ultimately do a lot more harm than good. We have already heard how compliance costs may well outweigh tax revenues, while many financial services companies, especially in Europe, are simply having nothing more to do with US clients, concluding that to do so would be more trouble than it’s worth. What’s more, it will be interesting to see how the IRS does cope with the information tsunami that is headed its way.

So, while the US government is well within its rights to crack down on those who use illegal means to evade US taxation, there are huge doubts as to whether FATCA is the right way to go about it. 


Tags: United States | banking | legislation | insurance | tax avoidance | banking secrecy | tax havens | Canada | European Union (EU) | France | Italy | Spain | United Kingdom | Ireland | investment



Back to Features

Tax-News Reviews

Cyprus Review

A review and forecast of Cyprus's international business, legal and investment climate.

Visit Cyprus Review »

Malta Review

A review and forecast of Malta's international business, legal and investment climate.

Visit Malta Review »

Jersey Review

A review and forecast of Jersey's international business, legal and investment climate.

Visit Jersey Review »

Budget Review

A review of the latest budget news and government financial statements from around the world.

Visit Budget Review »

Stay Updated

Please enter your email address to join the mailing list. View previous newsletters.

By subscribing to our newsletter service, you agree to our Terms and Conditions and Privacy Policy.

To manage your mailing list preferences, please click here »