Enacted by the US Congress in 2010, Foreign Account Tax Compliance Act (FATCA) will impose a new standard for preventing offshore tax evasion, overriding current international taxation structures. Among these are the OECD multilateral tax convention to which the US is a party, the US-Canada tax treaty which already addresses the FATCA objectives in Canada, and the IRS’s own Qualified Intermediary system, which FATCA seeks to extend and make more robust.
Intended to ensure that US citizens are fully taxed on the totality of their foreign assets, from 2013 FATCA will place the responsibility for enforcing this taxation on financial and non-financial institutions around the world.
Currently, the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters is the most comprehensive multilateral instrument available for tax co-operation. It provides for all possible forms of administrative collaboration between its parties in the assessment and collection of taxes, in particular with a view to combating tax evasion. The convention has recently been opened to all countries and updated to bring it in line with the international standard. Endorsed by the UN and the G20, the international standard provides for full exchange of information in all tax matters without regard to domestic laws or bank secrecy, while ensuring confidentiality of the information exchanged. As well as being comprehensive, the convention is also flexible and not only is it a voluntary agreement, it also allows countries to make individual reservations on certain issues.
‘Voluntary’ and ‘flexible’ are not part of FATCA’s vocabulary. Its predecessor -the Qualified Intermediary Programme implemented about a decade ago – had similar objectives but with far more limited provisions. It relied on financial and non-financial foreign entities to identify their US clients, withhold any taxes due on US securities in their accounts (typically 30%) and pay them to the IRS, all without disclosing the clients’ identity.
FATCA goes much further. In fact, it is probably the most extensive and far-reaching tax enforcement in history. Compliance is compulsory, unless institutions are prepared to quit US business (and the IRS would require proof of that on a regular basis). This is a very strong incentive to sign an agreement and report directly to the IRS information about financial accounts held by US taxpayers or foreign entities with substantial ownership by US taxpayers, as are FATCA’s key demands. The information required includes names, addresses, account and custody numbers, as well as custody holdings, account history and balances. Failure to provide this data on an annual basis (whether through the fault of the institution or individual account-holders) will result in institutions having to pay a 30% withholding tax on all US and certain non-US payments.
FATCA definitions are as exhaustive and wide-ranging as can be imagined. ‘Financial institutions’ are defined as any financial institution that is deemed a ‘foreign entity’ (non-US) and accepts deposits or holds financial assets for the account of others, or any organisation in the business of moving, investing or lending money, dealing in financial instruments or providing financial services. In practice, anywhere between 200,000 and 700,000 financial entities around the globe, including banks, brokers, investment companies, asset management institutions, fund structures, clearing houses, exchanges, etc fall under the scope of the new regulation.
The term ‘US account’ applies to foreign assets with an aggregate value exceeding US$50,000 and generally includes depository accounts, custodial accounts and non-regulatory-traded equity or debt interests held by a ‘specified US person’ or a ‘US-owned foreign entity’. This is taken to mean:
- US citizens residing in the US.
- US persons directly or indirectly controlling more than 10% of a foreign company.
- US persons linked to complex structures, such as foundations or trusts.
- Accounts held by US persons indirectly, green-card holders, etc.
The ‘withholdable’ payments class includes US source dividends, interest (including original issue discount) and other ‘fixed or determinable annual or periodical’ income (such as rents on property located in the US, payments for legal settlements, licencing fees, etc). Also included are any gross proceeds from the disposition of property that can produce US source interest or dividends.
The sweeping interpretation of ‘US account’ means that many non-financial foreign institutions are also affected. Withholdable payments made to these institutions are subject to a 30% withholding tax, unless they reports details of each substantial US owner or prove that they do not have substantial US owners. Non-compliance would result in taxing the entire withholdable payment, not just the US-owned portion of it.
Finally, ‘pass-thru payment’ is one of the most debated FATCA elements. It is defined as a payment made to a ‘recalcitrant’ (one that refuses to be identified) account holder to the extent of the amount of payment that is ‘withholdable payment’ plus the amount that is not ‘withholdable payment’ multiplied by the ‘pass-thru payment percentage’. The percentage differs depending on the type of payment and is determined by individual institutions based on the ratio between their US and total assets.
Reactions and Responses
The announcement of FATCA has triggered multiple responses to simplify, postpone or repeal the requirements. There is no doubt, however, that FATCA is going ahead and, in fact, US officials have stressed that they cannot undo a law enacted by Congress.
FATCA’s creators continue to solicit comments from stakeholders, although it is not clear to what extent they intend to accommodate the diverse and sometimes contradictory proposals. The European Banking Federation (EBF), for example, commends FATCA’s differential treatment of ‘private banking’ accounts, while the Swiss Bankers Association (SBA) actively opposes it. The SBA has calculated that it would result in additional cost-equivalent of 100,000 man-years to review manually (as FATCA demands) only 100,000 private banking accounts. The British Bankers Association (BBA) supports the European Commission’s (EC) proposal to explore the possible synergies between FATCA and the EU Savings Directive which has similar objectives. The Japanese Bankers Association (JBA) politely points out the existence of the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters.
Following the first round of consultations, the IRS has issued two highly technical notices, making compliance rules even more unrelenting than the earlier version. Having realised the magnitude of implementation challenges, the only leniency the IRS has shown so far has been to phase in the requirements and postpone the start date – but only by six months.
Although the full power of the new statute will not take effect until January 2014, organisations must be fully FATCA-equipped by June 2013, when they are expected to sign an agreement with the IRS. In the meantime, the complete and final version of FATCA obligations is expected in the summer 2012, with the IRS opening doors for electronic applications from institutions in January 2013.
FATCA vs European Union Savings Directive
The EC official response to FATCA has taken over a year to arrive. As a long term solution, they propose a tax co-operation agreement between EU and US based on the European Union Savings Directive. The Directive pursues similar goals to FATCA – to counter cross-border tax abuse – and provides for an exchange of information between tax authorities of EU Member States. Like FATCA, the EU Saving Directive requires financial intermediaries to report information on interest and other income of individual investors to their home tax authorities. Intermediaries may impose a withholding tax on account holders who fail to agree to this disclosure, and pay the amounts to the home countries. In some cases this can be achieved on an anonymous basis.
However, to date the EU has failed to secure consensus on the Directive’s provisions between the Member States. For two years running Luxembourg and Austria refuse to agree and insist on retaining their transitional right to impose withholding taxes rather than disclose account-holders’ information (the transitional period will end in 2014).
Can the EU influence the US Treasury’s vision of FATCA in Europe, when it is having a hard time convincing its own members? Additionally, the EU Savings Directive has fundamental flaws, such as the failure to account for US citizens with dual nationality. It is more likely that the Directive will have to adapt to FATCA’s terms, not the other way round. When it comes to Americans hiding assets abroad, FATCA does not negotiate.
Challenges and Opportunities
There is a renewed international interest in a global system for tax information exchange, as articulated by the G20 and OECD. Through the comprehensive and rigid mechanisms that FATCA seeks to establish, it is positioned to become a standard-setter for a competent multilateral tax instrument. Resources invested in compliance will lay the foundation for an infrastructure capable of responding quickly to emerging regulatory requirements, as governments steer towards an internationally-approved taxation structure.
FATCA is not just another regulatory burden for the otherwise overregulated institutions. It is an opportunity to refine systems and processes, including customer data quality and availability and customer communication, and to transform compliance into a source of operational improvement in preparation for the worldwide taxation master plan.
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