FATCA: Ushering in a New Reporting Regime

FATCA’s architects worked quietly, paving the way for future revenues to accrue to the US government while simultaneously passing on the underlying associated costs to foreign financial institutions (FFIs). An FFI is defined as any entity that:

  • Accepts deposits in the ordinary course of a banking or similar business.
  • Holds financial assets for the account of others as a substantial portion of its business.
  • Engages or holds itself out as being engaged, primarily in the business of investing, reinvesting, or trading in securities.

The term includes banks, private equity funds, hedge funds, venture capital funds (VCFs), managed funds, institutional investment funds (IIFs), retirement funds and trusts, insurance companies, securities brokers and dealers, collective investment units, securitisation vehicles, special purpose vehicles (SPVs) and other investment vehicles.

FATCA targets only US citizens, green card holders or the five other criteria that are determinants of US status, but its financial, compliance, legal and regulatory implications represent a quagmire for FFIs and their officials.

FATCA was introduced in 2010 when President Obama signed the Hiring Incentives to Restore Employment (HIRE) Act. With US unemployment above 8% since 2008, the HIRE Act aimed to incentivise businesses to take on jobless workers on their payroll. Various revenue generating provisions, including FATCA, were proposed to fund these incentives. The objective of FATCA is to prevent US taxpayers from avoiding the payment of US income taxes by hiding assets and money offshore. FATCA provisions are scheduled to become effective in a series of staggered deadlines commencing 1 January 2013.

Main Provisions of FATCA

FATCA requires US taxpayers who meet one of the criteria listed below to report information about all their offshore assets, in their annual tax returns submitted by them from the 2012 filing season. At present, the criteria determining the US status of a tax payer are as follows:

  • US citizenship or a permanent resident status (green card).
  • A US birthplace.
  • A US residence address or correspondence address (including a US PO box).
  • Standing instructions to transfer funds into an account maintained in the US or directions regularly received from a US address.
  • An ‘in care of’ address or a hold mail address that is the sole address with respect to the client.
  • A power of attorney or signatory authority granted to a person with a US address.

The scope of FATCA also extends to non-financial foreign entities (NFFEs), or non-US entities which are not FFIs. For example, a Bahrain-based real estate company is deemed to be a NFFE. The FFI does not have to report details on the NFFE to the Internal Revenue Service (IRS), unless there is ‘substantial US ownership’ in the real estate company. Under FATCA, ‘substantial’ is defined as 10% or more US ownership, or 10% or more US beneficiaries of non-US trusts.

The greatest impact of FATCA is on FFIs, as it requires them to report directly to the IRS on information concerning financial accounts held for US taxpayers or for foreign entities in which US taxpayers hold a ‘substantial ownership’ interest (defined as 10% or above). To comply with the new disclosure requirements, each FFI is expected to enter into a special agreement with the IRS by 30 June 2013. Signing such an agreement enables the FFI to be deemed as a ‘participating FFI’ in the eyes of the US Treasury. FFIs that refrain from signing an IRS agreement are categorised as ‘non-participating’ FFIs.

There are certain reporting exemptions for NFFEs, including garment factories, family trusts, start-up companies, liquidating companies, financial entities emerging from reorganisation or bankruptcy, hedging/financing centres within corporate groups and insurance companies that do not issue cash value life insurance or annuities.

Going forward, the onus is on participating FFIs to report annually for all accounts with a value of US$50,000 and above:

  • The name, address and taxpayer identification number (TIN) for each account holder deemed a US person as per the above criteria. In case the account holder is a foreign entity where the ownership stake by a US person is 10% or above, the name, address and TIN of each substantial US owner of the entity must be disclosed.
  • The account number.
  • The account balance or value at year end.
  • Gross dividends, interest and other income paid or credited to the account.

Individual and corporate accountholders or other FFIs that fail to provide sufficient information to determine whether or not they are US persons are deemed to be ‘recalcitrant’ account holders. FATCA tightens the tax net by mandating all participating FFIs to withhold and pay over to the IRS, 30% of all US-generated withholdable or pass-through income that accrues to the accounts of the recalcitrant individuals or entities.

Withholdable payments are defined as:

  • Any payment of interest, dividends, rents, royalties, salaries, wages, annuities, licensing fees and any other fixed determinable annual or periodical payments (FDAPs).
  • Gross proceeds from the sale or disposal of US property.
  • Gross proceeds realised from the sale of US debt or equity securities.

Pass-through payments are defined as “any withholdable payment and any other payment to the extent it is attributable to a withholdable payment”. They originate mainly when the participating FFI is an intermediary; for example where it acts as a custodian, broker or other agent. The intention of FATCA to impose the withholding on pass-through payments was to capture multiple intermediaries leading to the end account holders. This becomes more complex for administrators of feeder funds, or fund of funds (FOFs) that earn US-sourced income. Pass-through payments are subject to FATCA withholding effective 1 January 2015.

Onus on Foreign Financial Institutions

All financial institutions incorporated outside the US that receive income from US sources on either a proprietary or fiduciary basis, must comply with FATCA provisions in order to avoid the 30% withholding tax. As most financial institutions in liberalised markets (where the financial system and its regulator permits foreign currency dealings) have a US dollar (USD) nostro, chequing or custodial accounts with a US entity, they have to enter into a disclosure agreement with the IRS and agree to:

  • Have robust Know Your Customer (KYC) diligence procedures to identify US account holders.
  • Submit the annual reporting requirements for their US account holders.
  • Deduct and withhold 30% of US sourced income earned by recalcitrant account holders or non-participating FFIs.
  • Comply with the IRS’ requests for additional information.

Most insurance companies are also subject to FATCA, as annuity payments and proceeds from life insurance contracts received by non-US persons from a policy or contract issued by a US insurer, or its foreign branch are treated as a fixed determinable annuity payments. The only exception is insurance companies that issue contract with no cash value such as property and casualty policies.

Challenges for FFIs

FFIs face a host of internal and external challenges, the main internal ones including:

Revalidation of the KYC process
Although maintaining KYC information is mandatory under the Financial Crime Module of the Central Bank of Bahrain’s rulebook (CBB), FFIs will need to revalidate their KYC processes to identify potential US residents based on their US birthplace, US residence address or US correspondence/hold mail/in care of address; review existing standing orders to determine whether funds are being transferred regularly to an account maintained in the US or directions regularly received from a US address; and review existing powers of attorney or signatory authorities granted to a person with a US address. As few technology systems capture existing information on the above criteria for US indicia, an initial manual validation of the underlying documents will be required, as opposed to conducting an electronic search. The process of monitoring and tracking for change of circumstances, is another area that needs to be visited. 

FFIs will also have to conduct further due diligence with respect to customers who have a US place of birth. This entails procuring a self-certification that the account holder is neither a US citizen nor a US resident for tax purposes or holds a non-US passport. In the latter case, a copy of the individual’s certification of loss of nationality of the US, or a reasonable explanation of the reason why the individual does not have such a certificate despite renouncing US citizenship or the reason the account holder did not obtain US citizenship at birth, will have to documented by the FFI.

Technology challenges
Those faced by FFIs will result in costs incurred in upgrading its core banking systems to attain robust capabilities in the areas of:

  • Storing documentation: Capturing process changes and reviewing the customer base. Technology challenges are enhanced in the case of account holders who maintain dual nationality, but have not declared their US nationality due to personal or legal reasons. The majority of core banking systems are not programmed to store multiple nationality codes, passport numbers, social insurance numbers, TINs, and correspondence addresses.
  • Ensuring withholding taxes: Building functionality to enable a system generated withholding process for recalcitrant account holders.
  • Reporting: Building and integrating data across branches and products, to ensure that the reports capture the account balances, assets and gross payments.

Data collection, cleansing and storage
Data issues are compounded if a financial institution has multiple information technology databases where customer static and transaction data is stored; for example, core banking, credit card, investment banking, asset management, trade finance or loan systems. Data will have to be integrated from the multiple sources and cleansed, in order to meet FATCA reporting requirements. 

Need for a consistent and co-ordinated approach
Unless properly organised, financial institutions with inaccurate or inadequate client data face the risk of misclassifying clients and inadvertently not imposing the 30% withholding tax on them. Those without a centralised operations team have to communicate with multiple business units/branches to ensure the data gathering process is managed in a coordinated fashion across all their operations. 

Greater supervision and responsibility vis-a-vis outsourcing providers
Institutions which have outsourced their KYC documentation and retention, account opening and closing processes, maintenance of static data and management information space (MIS) generation, must ensure that the outsourced vendors are suitably trained on FATCA requirements. Information should be available within short turnaround periods. It is the responsibility of the FFI to pay greater attention to the outsourced processes to ensure completeness and accuracy of data.

Building a FATCA culture
The success of a FFI in complying with FATCA depends on its ability to align the key stakeholders including the board of directors, the chief executive officer (CEO) and the senior management team, operations, compliance, IT, risk and legal departments.

1. The main external challenges for FFIs involve walking the tightrope between data privacy, client confidentiality and FATCA compliance include:

Procuring information release waivers from clients in order to navigate cross-border privacy concerns and regulations. Bahrain-based foreign institutions must abide by the Central Bank of Bahrain’s (CBB) rulebook that states that banks must not publish or release information to third parties concerning the accounts or activities of their individual customers, unless:

  • Such information is requested by the CBB or by an order from the courts.
  • The release of such information is approved by the customer concerned.
  • It complies with the provision of the law or any international agreements to which the Kingdom is a signatory.

The challenge to the FFI arises when it has to deal with a recalcitrant customer who refuses to provide a waiver, or a client who is silent and ignores communication from the bank seeking consent. This puts the FFI in the dilemma of either reporting the client’s information to the IRS and contravening the CBB’s rulebook, or adhering to the CBB’s rules and breaching FATCA norms. Following the latter option will result in the FFI being penalised with a 30% withholding tax on all its US income that is due to its own proprietary interest, as well as other cooperating/unaffected customers. 

2. Practical issues in closing accounts: While FATCA rules instruct the FFI to close a recalcitrant customer’s account, circumstances may prevent it from taking such a step. This is especially true for retail FFIs, which have assets and liabilities outstanding to the recalcitrant US customer. Mandatory closure of the account will result in the FFI being unable to recover its exposure to the client (in the form of mortgage loans, credit cards and other banking facilities provided to the client). This presents the FFI with a quandary of either complying with FATCA and risking its inability to recover its exposure to the customer due to closure of the account, or continuing to maintain the account and violating FATCA requirements.
3. Service quality and the need for sensitive customer relationship management: Given our global society, clients may have a relationship with the same financial institution in multiple jurisdictions. If internal FFI data sharing is not permissible legally, related entities of the same FFI in different jurisdictions may each have to approach the same client with similar information requests. This involves the need for extra effort by customer relationship teams, to ensure that KYC documentation requirements are standardised and that the client relationship is not jeopardised.
4. Unforeseen litigation: If the FFI is penalised by the IRS and subjected to the 30% withholding tax due to recalcitrant account holders, the earnings of non-US customers banking with the FFI are also subject to the withholding tax. It is fair to assume that such customers can sue the FFI for failing in its fiduciary duties by withholding 30% of their income.

5. Greater degree of administration: A recent Journal of Accountancy article stated that taxpayers residing outside the US could be detained at the border, questioned and flagged for follow-up enforcement on unpaid or back taxes. If the taxpayer had an unpaid tax liability, the IRS could submit identifying taxpayer information to the Treasury Enforcement Communication Systems (TECS), a database maintained by the Department of Homeland Security. TECS contains details of all foreign bank and financial accounts used by individuals, partnerships, trusts or corporations having a financial interest in or authority or signatory over one or more bank accounts, securities accounts, or other financial accounts in a foreign country. Until now, TECS has been populated with data provided by US taxpayers. It appears that going forward, the IRS will populate it with information received from the participating FFI. Any discrepancy between the accounts or amounts declared by the US taxpayer and the FFI, will initiate further questions directed to the underlying FFI.
The CBB’s rulebook also states that “when information has been provided by a CBB licensee directly to an overseas authority, the details of the request and the information provided must be sent to the CBB simultaneous to the provision of information to the overseas authority.” In future, each FFI will have to devote more time and resources to handle any IRS related query.

The above challenges are not comprehensive, but merely a few of the operational, reputational and compliance risks that the FFI will be exposed to under the FATCA regime.

Penalties for Non-compliance

Individual and corporate US taxpayers who fail to report their financial assets are subject to a penalty of US$10,000 and up to a further US$50,000 for continued failure after IRS notification. Additionally, the understated amount of tax attributed to non-disclosed foreign financial assets, will be subject to a penalty of 40%.

FFIs that choose not to sign the agreement with the IRS are subject to a 30% withholding tax on their own and their customers’ US-sourced income and sales proceeds from the sale of passive US investments. A 30% withholding tax on sales proceeds is a harsh punishment, applicable irrespective of whether there is a gain or loss incurred on the sale of the investment. Such institutions also risk being ostracised by their banking counterparties, as it is expected that participating FFIs will be intent to not have any recalcitrant account holders in their chain of payment flow. Failure to do so would result in their being subject to the 30% withholding levy.

Intergovernmental Agreements (IGAs)

FATCA’s requirements are of concern to various governments including those of the UK, France, Germany, Italy and Spain. In February 2012, the US Treasury stated that it would work towards an intergovernmental agreement to address the legal barriers for these EU countries to comply with FATCA, establish a reciprocal approach to exchange information and reduce the cost of compliance for financial institutions located in the five jurisdictions. The legal barriers arose from EU data protection laws and consumer protection laws that made it difficult for the five EU countries to comply with the reporting, withholding and account closure requirements imposed by FATCA.

In July 2012, the US Treasury issued a joint statement along with the five governments that publicised a model intergovernmental agreement (IGA). This is available on a reciprocal and non-reciprocal basis – reciprocity involving the US Treasury collecting and reporting to the authorities of the FATCA partner information on the US accounts of residents/citizens of the FATCA partner. The proposed IGA framework provides for a partner country (FATCA partner) to:

  • Pursue the necessary legislation to require FFIs in its jurisdiction to collect and report to the authorities of the FATCA partner.
  • Enable FFIs established in the FATCA partner to apply the necessary diligence to identify US accounts.
  • Transfer to the US on an automatic basis, the information reported by their FFIs.

In turn, the US Treasury agreed to:

  • Eliminate the obligation of each FFI established in the UK, France, Germany, Italy and Spain, to enter into a separate comprehensive FFI agreement directly with the IRS (the FFIs still need to be registered with the IRS).
  • Permit FFIs established in these countries to comply with their reporting obligations under FATCA by reporting information to the FATCA partner, rather than violating cross -border secrecy laws by reporting directly to the IRS.
  • Eliminate US withholding under FATCA on payments to FFIs established in the FATCA partner, by identifying all FFIs in the FATCA partner as participating FFIs or deemed compliant FFIs.

Key changes of the IGA
Under the newly released IGA agreements, financial institutions in the FATCA partner are classified as one of custodial institution, a depository institution, an investment entity or a specified insurance company.

The obligations of these FFIs include:

  • Requiring FFIs in partner countries to register with the IRS, as opposed to entering into a full FFI agreement.
  • Enabling all branches and entities of the FFI to be covered by the local jurisdiction laws.
  • Removing the requirement to close or levy a withholding tax of 30% on all recalcitrant accounts.
  • Enabling a group to have a non-participating FFI for reporting and withholding purposes, without being subject to the 30% withholding penalty.

Advantages of the IGA
The intergovernmental approach will solve some, if not all, challenges of FATCA. The main ones are:

  1. Resolving the contraction with local data privacy laws: Under FATCA, non-US FFIs and funds face the dilemma of either complying with FATCA requirements or violating local data protection, banking secrecy and customer confidentiality laws. FFIs incorporated in any country adopting the IGA approach would be permitted to report the US taxpayer’s information to the authorities within the country; that is the home country regulator. Consequently, the FFI has the assurance that it is not violating any legal, constitutional or judicial laws as no information is released overseas.
  2. Suspension of rules relating to recalcitrant accounts: The US Treasury will not require a reporting financial institution to withhold a 30% tax with respect to any accounts held by a recalcitrant account holder, or to close such an account. As mentioned, closing requirements could result in institutions violating local law, their contractual obligations to their customers, or both. This risk is now eliminated.
  3. Identification and treatment of other deemed compliant FFIs and exempt beneficial owners: The IRS has agreed to treat each non-reporting financial institution of the FATCA partner as a deemed-compliant FFI, or as an exempt beneficial owner. This reduces the administrative burden on foreign financial institutions.
  4. Customer-identification procedures have been simplified: The model IGA also simplifies the requirements that financial institutions in a FATCA partner must follow to determine whether an account belongs to a US person. Among other things, the model IGA places increased reliance on information collected pursuant to applicable anti–money laundering (AML) and KYC rules. An electronic search will suffice for accounts below a particular threshold.
  5. Lower administrative costs and turnaround time if the FFI reports to the local regulator: In the absence of an IGA, Bahrain-based FFIs would have to notify or possibly seek the prior approval of the CBB prior to reporting the account and transaction details of any queries that are raised by the IRS.

There have been questions raised amongst the global financial community as to whether FATCA will be enforced, and also whether its effective date could be delayed. FATCA has been signed into law with an effective date of 1 January 2013, as it would take an act of Congress to change it.


There is no doubt that FATCA heralds a new reporting era for FFIs. As new guidelines continue to emerge, it is imperative for financial institutions to be well informed on the requirements and to work towards meeting them. 



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