FATCA: Already at your doorstep!

Monday, 21 April 2014 00:00 -     - {{hitsCtrl.values.hits}}

The ‘Foreign Account Tax Compliance Act’ (FATCA) is a unique anti-tax avoidance law conceptualised by the US Inland Revenue. Its uniqueness stems from the fact that although it is a US law, it affects financial institutions the world over. FATCA resulted from the efforts of President Obama’s campaign to crack down on tax evasion by US taxpayers through investment in offshore accounts. FATCA rules require US based financial institutions as well as Foreign Financial Institutions (FFI) to identify their US accounts and report them periodically to the US Revenue. It does not stop at just that; non-compliance can possibly prove costly for FFI. It could earn the FFI the tag of “non-participating FFI” with adverse consequences e.g., a 30% withholding tax from US income streams along with the FFI’s group getting tainted with the tag and possible loss of business, etc.     Who is impacted? Essentially FATCA would impact financial institutions that:
  • Accept deposits;
  • Undertake activities of investing or trading in securities, on behalf of clients;
  • Hold financial assets for others and provide related financial services; or
  • Insurance companies issuing cash value or annuity products.
In other words, FATCA would impact various financial institutions such as banks, custodians, depositories, insurance companies, funds/funds managers, securities traders, broker/dealers etc. A key misconception about FATCA is that it applies only to FFIs with US customers. That is not the case. FATCA compliances affect FFIs in general and even non-financial entities. Even FFIs with a purely local customer base will need, in the least, to register and provide required certifications. Non-financial entities will also have to gear up to provide required certifications to their financial service providers.       How FATCA works Now let’s understand the way FATCA works and the way it has evolved over time. In January 2013, the US treasury released the Final FATCA Regulations. In the Final Regulations, the US treasury has attempted to address a number of stakeholder recommendations to the proposed regulations released in February 2012. Under these, FFIs in general were required to register with the US Inland Revenue and sign FFI agreements. These agreements would bind the FFIs to, amongst others:
  • Upgrade their client on-boarding and change management policies and procedures;
  • Undertake enhanced due diligence procedures to identify “US accounts”, report on these accounts to the IRS; and
  • Withhold 30% tax on all US withholdable payments made to ‘recalcitrant’ (read: non-consenting US accounts) or non-participating institutions.
Failure to sign up the FFI agreement or effectively comply with it, invites penal FATCA withholding at 30% from all US streams of withholdable payments for the FFI. The US Treasury being conscious of the significant onus thus cast on all FFIs, besides their predicament to deal with conflict between FATCA and local secrecy laws, laid an alternative concept of inter-governmental agreements (IGA). This would entail passing on information to US through our local government without breaching the secrecy laws. Under this approach, the foreign government could also choose to gain from reciprocity of information (about its own taxpayers from US financial institutions). In fact, the US has already put in place mechanism for capturing information on interest paid by US financial institutions to non-residents, by expanding its current information reporting regime.  This should enable the US to give out information to other countries under reciprocal agreements. In July 2012, the US Treasury released two basic models of IGA. Under Model 1, the ‘FATCA Partner’ government is tasked with collecting information from resident FFIs and reporting it to the IRS. There are two versions of Model 1 – reciprocal and non-reciprocal versions. Canada, Costa Rica, Denmark, Finland, France, Germany, Guernsey, Honduras, Hungary, Ireland, Isle of Man, Italy, Jersey, Luxembourg, Malta, Mauritius, Mexico, Netherlands, Norway, Spain and the United Kingdom, have adopted the reciprocal version of this agreement; whereas the Cayman Islands has adopted the non reciprocal version. Model 2 agreements would work with countries which see domestic legal or administrative impediments in entering into a Model 1 agreement (that requires significant administrative involvement on the part of the foreign government). Under this model, the FFI would report directly to the IRS with minimal involvement of the foreign government. Bermuda, Chile, Japan and Switzerland have signed the Model 2 agreements. US IRS has also released the list of jurisdictions that have reached agreements in substance and have consented to being included on this list (Australia, Belgium, Brazil, British Virgin Islands, Croatia, Czech Republic, Estonia, Gibraltar, India, Jamaica, Kosovo, Latvia, Liechtenstein, Lithuania, New Zealand, Poland, Portugal, Qatar, Romania, Slovak Republic, Slovenia, South Africa, South Korea (Model 1 IGA); and Austria - Model 2 IGA). Keeping in mind the benefits of an IGA, one would expect that the Sri Lankan Government may also, ideally, enter into an IGA for FATCA. This would be a welcome move for Sri Lankan FFIs as it would significantly eliminate the key concerns, namely, directly reporting into a foreign government, undertake withholding and seeking waivers from customers.       Key timelines Such developments apart, as far as the timelines go, the deadlines are laid down – in fact, these have been recently extended. Every FFI is expected to register on the online portal and obtain a Global Intermediary Identification Number (GIIN). The first cut-off date for registration for countries other than Model 1 IGA has been extended to 5 May 2014 from 25 April 2014.  Countries with Model 1 IGA have the leeway to register before 22 December 2014.  Importantly, the compliance would begin from 1 July 2014. So, FFIs are obliged to have procedures in place to identify US persons while opening any new account. Also, they should remediate/obtain requisite documentation on their existing accounts (accounts existing as at 30 June 2014).  Withholding on payments to FFIs will start from 1 July 2014. These timelines would apply unless any IGA specifies otherwise.       Latest global developments Tax administrators all over the world have come to realise the strengths of establishing extensive information reporting systems. The US went one step ahead in that direction with FATCA, UK and OECD followed the suit. OECD has released the Global Standard for Automatic Exchange of Financial Account Information commonly known as GATCA. This model for global automatic tax information exchange is based on FATCA Model 1 IGA. There is an ambitious time line for delivery of this framework - exchange of information scheduled to commence by end of 2015. The UK has stated that it will look to sign IGAs with other countries as part of its commitment to combat tax evasion. All the Crown Dependencies have entered into automatic tax information exchange agreements with the UK.       Next steps Registration with US IRS: For all FFIs, the first registration cut- off date is 5 May 2014 to include name on the first FFI list to be published on 2 June 2014. As per Notice 2014-1 issued by the IRS, it appears that FFI in Model 1 IGA countries have an extended timeline to register by 22 December 2014 as the withholding in such countries shall begin only on or after 1 January 2015, provided there are no branches in countries not having Model 1 IGA. The implications of non-registration on the entire expanded affiliated group shall be looked upon before finalising on the time it needs to register. Impact assessment: For the time being, Sri Lankan financial institutions need to ready themselves to be able to take on their FATCA responsibilities. A systematic impact and gap analysis of FATCA on their business, especially, customers, products, processes and systems will help understand current level of preparedness and further course of action.       Conclusion No doubt, these are challenging times for financial institutions all over the world and Sri Lankan institutions are no exception. FATCA is here to stay and its close cousin is also coming soon. It is high time for Sri Lankan financial institutions gear up for the challenge. (The writer, LLB, Attorney at Law, ACMA, is Principal – Tax & Regulatory, KPMG.)

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