Against a backdrop of consistent fiscal deficits and increased visibility of perceived offshore tax abuses by US citizens and corporates, the Foreign Account Tax Compliance Act (FATCA) was signed into law on 18 March 2010. FATCA introduces a new Code chapter 4 reporting regime that is designed to reduce offshore tax abuse by imposing a penal 30% withholding tax on payments received by some foreign entities that refuse to disclose, or are unable to disclose, the identities of US persons with accounts at those foreign entities (e.g. American’s or unknown nationalities having bank accounts outside of the US).
FATCA is a reporting regime that is intended to provide the Internal Revenue Service (IRS) with data from which it can investigate and assess US taxpayers’ compliance with their obligations. While the enforcement mechanism is the penal withholding tax, the US government’s own estimate forecasts less than US$10bn of additional tax review over the first 10 years of FATCA. This has led to questions of the proportionality of FATCA given the significant implementation costs to both the government and the private sector. In any case, FATCA is now law and in fact, many other jurisdictions are reported to be considering similar rules.
What Does FATCA Require?
Non-US financial institutions (foreign financial institutions or FFIs) that accept deposits, hold financial assets for others or invest or trade in securities, which enter into an agreement with the IRS (an FFI agreement) commit to becoming FATCA compliant. Compliance requires the FFI to identify US persons who have accounts and report those US persons to the IRS. This will drive the FFIs to implement appropriate systems and controls. Owing to due diligence requirements, having zero US passport holders is not an exemption from implementing FATCA.
For pre-existing accounts, the FFI is required to review the information that it holds on customers to establish customers’ US or non-US status. An enhanced level of review is required for non-entity accounts with a balance of greater than US$1m. Where existing data is insufficient to draw a conclusion, new data must be sought. For new accounts, the FFI is required to have processes in place to capture the necessary information upon account opening.
Signing the FFI agreement also obligates the FFI to identify whether non-individual (non-financial foreign entities or NFFEs) accounts are ultimately held or controlled by US persons either directly or indirectly. This covers trusts, company accounts, funds and special purpose vehicles.
Withholding and reporting
Where the FFI has entered an FFI agreement, some payments to the following payees may be subject to FATCA withholding at 30%:
- Another FFI which has not signed an FFI agreement.
- An individual which has not provided sufficient evidence to prove their US or non-US status (i.e. a recalcitrant account).
- An NFFE that has not certified that it has no substantial US owners (also a recalcitrant account).
There are a number of different types of payees to which FATCA withholding and reporting would not apply. These payees are those which typically pose a low risk of facilitating significant US tax avoidance such as certain local financial institutions which operate in a single jurisdiction, low balance accounts, property and casualty insurance providers and publicly traded organisations to name just a few.
The implementation dates for the different aspects of FATCA vary, but these are broadly the available dates:
- Withholding on payments on income starts 1 January 2014, while withholding on gross proceeds begins from 1 January 2015.
- Initial reporting commences 30 September 2014, with additional fields to be reported on through to 2016, when full reporting will be required.
- There are two years from the effective date of the FFI agreement given to complete due diligence on existing accounts, unless the enhanced review is required. That needs to be completed within a year.
Draft FFI agreements are expected in the next few months and the online portal for FATCA registration should be available later this year.
What Needs to be Done?
Now that draft regulations have been issued, organisations are in much better positions to determine the impact of FATCA on their activities. While NFFEs will not be required to sign up for FATCA, NFFEs should consider whether FATCA withholding could apply to payments received and, if none of the exemptions apply, whether the organisation is able to certify that it has no substantial direct or indirect US owners.
The assignment for FFIs is much larger and work should already be underway. In particular, FFIs should be:
- Educating senior management on the costs and consequences of non-compliance.
- Considering the impact of FATCA on customer types, products, business units, customer on-boarding and due diligence requirements, reporting software and offshore operations to assess the scope of work required.
- Assembling a core project team at head office as well as in other countries which the organisation operates. This team should incorporate expertise from a withholding tax and operations perspective, as well as IT, legal and risk specialists.
- Considering potential conflicts with local legislation and regulation, such as privacy and secrecy requirements, and any remedial steps that may be required such as obtaining waivers from customers.
- Promoting customer awareness through appropriate marketing and communication channels.
- Monitoring US Treasury and IRS guidance as released and participate in FATCA industry groups.
FATCA is a very wide-ranging regime which will impact on many aspects of an organisation. FATCA may require significant system enhancements, a multitude of changes to the controls and procedures used when opening new accounts or establishing new relationships, and the reworking of many operational processes. It should not be viewed as simply a withholding tax project and it will require a multi-functional project team to ensure all areas are fully addressed.
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