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FATCA rules require US based financial institutions as well as Foreign Financial Institutions (FFIs) to identify their US accounts and report them periodically to the US Inland Revenue Service (IRS). 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.
FATCA also requires financial institutions around the world, including Sri Lanka, to register and comply with the FATCA regime – the process is easier said than done and has a number of implications to the registering nation.
At the UTO EduConsult seminar KPMG India Partner Tax Naresh Makhijani and KPMG Sri Lanka Principal Tax Suresh Perera shared key insights into FATCA and its implications on Sri Lanka and financial services industry including banks, insurers, fund managers and companies.
Why FATCA?
The US Treasury has lost nearly $ 100 billion during the past decade to offshore tax evasion. The Government, having identified the impact on its economy if the trend continues, enacted FATCA requiring US residents and those having US residency as customers to disclose information on offshore assets and income.
The Act is designed to increase compliance by US tax payers rather than to enforce collection from foreigners, and for this, foreign financial institution are required to report information related to the ownership of assets of US persons held outside their country.
Taxpayer identification numbers and source withholding are used to enforce foreign tax compliance, and mandatory withholding is often required when a US tax payer cannot confirm the US status of a foreign payee.
How the regime came about
The IRS previously instituted a Qualified Intermediary (QI) program under Inland Revenue Code which required participating foreign financial institutions to maintain records of the US or foreign status of their account holders and to report income and withhold taxes.
A US Government Accountability Office (GAO) report revealed that one report found that participation in the QI program was too low to have a substantive impact as an enforcement measure and was prone to abuse.
An illustration of the weakness in the QI program was that UBS, a Swiss bank, had registered as a QI with the IRS in 2001 and was later forced to settle with the US Government for $ 780 million in 2009 over claims that it fraudulently concealed information on its American account holders.
Provisions
FATCA typically has three main provisions. The first is that it requires foreign financial institutions such as banks, to enter into an agreement with the IRS to identify their US account holder and to disclose details such as account holders’ names, TINs, addresses, and the transactions of most type of accounts. However, some accounts such as retirement savings and other tax-favoured products are noted to be excluded from reporting on a country-to-country basis.
US payers making payments to non-compliant foreign financial institutions are required to withhold 30% of gross payments from foreign financial institutions, which are themselves the beneficial owners of such payments, are not permitted credit or refund of withheld taxes absent a treaty override.
The second is that US persons owing these foreign accounts or other specified financial assets must report them on a new form No. 8938, which is filled with the US tax returns if the accounts are generally worth more than $ 50,000.
A higher reporting threshold applies to US persons who are overseas residents and others. Account holders would be subject to a 40% penalty on understatements of income in an undisclosed foreign financial asset.
Understatements of greater than 25% of gross income are subject to an extended statute of limitations period of six years. It also requires taxpayers to report financial assets that are not held in a custodial account, i.e. physical stock or bond certificates.
The third is that it closes a tax loophole that foreign investors had used to avoid paying taxes on US dividends by converting them into ‘dividend equivalents’ through the use of swap contracts.
Who is impacted
There are four segments that will be impacted with the implementation of FATCA. The institutions are those that accept deposits, undertake activities of investing or trading in securities on behalf of clients, those that hold financial assets for others and provide related financial services, and insurance companies issuing cash value or annuity products.
Simply put, FATCA would impact the operations of various financial institutions such as banks, custodians, depositories, insurance companies, fund managers, securities traders, brokers and dealers.
However, a common misconception about the US tax regime is that it is thought to apply to only FFIs with customers. While it is not so, FATCA compliances affect all FFIs and non-financial entities as well.
FFIs with a purely local customer base will also need to register and provide required certifications, whereas non-financial entities will have to gear up to provide required certifications to their financial service providers.
How can the reporting take place?
The reporting can take place in two forms, one is by local financial institutions entering into the foreign financial institution agreement with the IRS, and the other is through inter-governmental agreement.
To date about 26 countries have executed and signed intergovernmental agreement and 19 more have agreed to do the same.
What is required from a FATCA point of view?
KPMG India’s Makhijani emphasised the need for financial institutions to identify the products that are impacted with the compliance of the IRFS.
The second is that from 2 July when on-boarding new accounts, financial institutions will have to comply with FATCA. There are six to seven criteria that are spread out in the FATCA rules that need to be complied with to determine that a certain customer is a US certified person or not.
“Irrespective of existing accounts, there is a remediation that has been laid down and that is over the period of three times the lifecycle. While that is not important as of now, what is important is the on-boarding of new clients. Institutions need to upgrade the systems,” he said.
The registration or signing up of US financial accounts which was to expire on 25 April has been extended by ten days, to 5 May.
How it works
Initially it was thought of having directly an FFI agreement with the US IRS. Based on representation and dialogue with various stakeholders and industry leaders, the view was that when the process goes only this far, there are local secrecy rules, and the Banking Regulation Act prohibits the institution from passing on the information of a customer.
Makhijani pointed out that in India, although the bank has the consent of the customer, they are bound by banking secrecy laws. “It is important that the banking secrecy laws be addressed. This was identified to be the biggest impediment if they went ahead with the FFI.”
If there is a non-consenting customer, the bank is expected to discontinue its customer relationship. This is identified to be a downside since an institution is expected to close all relationships with that customer, who then might opt for service from a competitor.
Even if they have gone only to the extent of an FFI, non FATCA compliant institutions are expected to close accounts of a non-consenting customer and transfer them to a financial institution that is FATCA compliant. More importantly, tax to the extent of 30% is to be withheld.
“The question is if the Sri Lankan tax authority will give credit for the 30% tax. They will not since it is punitive in nature. It is not tax as understood,” cautioned Makhijani.
He added it is important to look at FATCA from a business point of view rather than a tax point of view.
The alternative
Based on discussions held, the alternative is to go ahead with bilateral agreements which are of two types. IGA Model 1, which is that two governments enter into an agreement and the reporting obligation for local institutions, is to report the desired information through their government.
In such instances the accounts of non-consenting customers need not be closed since the US Government, on receiving the information from the local Government, will then instruct the local tax body on the necessary action to be taken.
In the IGA Model 2, the local banks will enter into an FFI directly with the US IRS. Only two countries, Japan and Switzerland have entered into this agreement type.
The status of Sri Lanka on FATCA
Sri Lanka is not on the IGA list and is not party to the multilateral agreement on tax information shared at OECD countries.
“Sri Lanka will have to reflect that as a country what it has to do. It is dependent on foreign capital and foreign remittance since it helps control the trade deficit,” said Makhijani.
The Banking Act of Sri Lanka consists of secrecy clauses. If going with the FFI agreement, banks will have to disclose client information, which is not accommodated in the law.
When looking at Section 77, it states that as a general rule no information can be shared with any party, but there are certain instances when it is required by a court of law.
While Sri Lanka will not follow the IGA Model 1 or 2 and opt directly for the FFI agreement, the question still remains if the nation is in a position to provide information to the IRS.
Although the Inland Revenue had stated that with the permission of the customer information can be shared, the decision is not certain as yet.
Pix by Upul Abayasekara
Local financial institutions seek clarifications on FATCATo increase awareness and clarify issues regarding the recently announced Foreign Account Tax Compliant Act (FATCA) of the US, local financial institutions were provided with a platform to clear their doubts in this regard.
In a panel discussion moderated by Daily FT Editor Nisthar Cassim, top industry experts such as KPMG India Partner - Tax Naresh Makhijani, KPMG Sri Lanka Principal - Tax Suresh Perera, NDB Bank Chief Executive Officer/Director Rajendra Theagarajah, Candor Equities Ltd. CEO/Director Ravi Abeysuriya and Union Bank of Sri Lanka Association of Compliance Officers of Banks/Head of Compliance Treasurer Chaya Gunaratne to share their views.
Following are excerpts:
Q: What has been the banking sector preparation towards this compliance?
Theagarajah: I think the Compliance Association of Practitioners of the banking sector has been doing a fair amount of work. From a broad macro perspective there was an attempt by the banks and certain CEOs to engage the regulator to try and look at the possibility of the IGA but from what I understand we have gone past that stage.
We have a system that could be categorised into two figures. One is Sri Lankan branches of foreign banks and they are better prepared but the current understanding for the agreed way forward for the local banks given that none of them would be compliant, or would be running of the danger of not meeting the 5 May deadline to register.
I understand that there is a 120 page explanatory document that is available online. The priority between now at the 5 May deadline will be to go through that process.
There are few issues in terms of the banking secrecy and in few areas where there are inconsistencies in terms of compliance and the regulations in Sri Lanka in terms of what seems to have been agreed with the Central Bank.
It is that the task force will work with the regulator and provide assistance for the registration and try to identify few of those inconsistencies and then get the necessary regulatory or institutional support.
Gunaratne: The regulator’s view is that the banks should go for the direct agreement with the IRS so the implication of that is that it will have a direct US body regulating the local banks to a certain extent. The KYC procedure will have to be aligned with certain US regulation requirements since at the moment we take lot of information but we don’t capture information such as place of birth. So those KYC procedures will have to be relooked and the documents will have to be aligned with certain requirements.
At the same time we will have to put in place certain systems and report requirements to identify the US persons.
The biggest problem will be the identification of the US entities where they have 10% shareholding where the US entities are concerned. We would do the best effect to get the declaration.
For the new accounts the regulators have said that they will get the legal impediment of Section 77 secrecy, that is where if the bank gets the customer consent in writing, we are able to comply with the reporting requirement. So the new accounts, the terms and conditions will have to be amended to include the waiver of the customer confidentiality clause but the problem is with the existing accounts where we have to write to every customer to get their consent. So that will be a huge process.
If the existing customer doesn’t consent what are we going to do? Should he have a clause that the bank will be under discretion to close the account. Closing the account is just a decision but it will have a business impact and this is a concern.
From the compliance officer point of view, the agreement has to have a reporting officer. The obligation the bank has to comprise, and especially there has to be a reporting officer.
Those are the basic implications we will see. There will be a lot of process changes to comply with these regulations.
Q: The IGA is not encouraged locally, why is such an arrangement avoided?
Theagarajah: The subject of the IGA is a thing of the past. Beyond the basic business needs there is something important for local banks planning to do international business. Some of the bills and bond issues, and the bilateral loans, all have this clause that asks if they are FATCA compliant. And once you say yes you have to go through the process. There is a huge cost. The sooner you start with the process it is better.
Q: What role can the Government play to expedite the process?
Makhijani: As of now what I understand is that the Central Bank has already instructed all the banks that they should proceed with FFI and maybe over a period of time they will shift to IGA.
IGA will certainly take time since there are lots of stakeholders and there are sensitivities involved. At the end of the day it is about doing it right.
Q: For financial institutions the deadline is 5 May? Is this priority now?
Makhijani: Yes. We are expecting the Indian Government to come up with an MoU before this date so that they are treated at least as an IGA-compliant country.
Q: What is the Impact on fund managers?
Abeysuriya: I think we are starting rather late. We should have got this going two or three years ago. The CBSL had a meeting on this just last week. Most of the local brokering community and asset managers are not aware of this. We brought it up and asked what we should be doing. What I understand of the CBSL discussion is that if you don’t register there will be lots of repercussions. My view is that you will not be able to deal with any bank that is not FATCA compliant. All banks will comply and register and will require any organisation that they are dealing with in this category to be FATCA compliant.
Maybe our SEC regulator and the CSE may have to be proactive and educate the whole local communities and the unit trust companies on how to get this done. I don’t think compliance officers are aware that they have to do this before 5 May.
Q: It appears that Sri Lanka is not ready? Can the deadline be further postponed?
Makhijani: As per the reports this has been pushed twice. The first was 1 January 2013 and 20 May 2013. Later that was pushed to 1 Jan 2014 and then to 1 July 2014. I can’t say it will get postponed again. The point is that from a Sri Lankan perspective it is unlucky that anything will happen from the side of the Government. Institutions have the choice of deciding if they will sign the FFI or not. If you don’t register then you are out of the system. The registration is easy, but the 40 page document has obligation catered upon the institution. There are about two months to carry out even the due diligence.
Q: What would be the implication to the banks in the event the task force of the CBSL is unable to clear the anomalies with regarding the double tax agreement?
Perera: It is not the double tax we need to worry about but Section 77 of the Banking Agreement Act. The wording is such that it states there is a provision for furnishing of agreements under certain circumstances to third parties. In this context you need to obtain clearance if you can send document to the particular client if they can get their consent.
Makhijani: If the customer is not cooperative then you will have to close the account. That is the only option left. Because you will repost to the IFRS stating that the customer is not responding to you and they will inform you to close the account. If the back has already provided facilities to the customer then he will have to withdraw and cancel.
Q: could either party terminate the agreement unilaterally at any given time?
Perera: There is a provision for termination. Section 7 of the Participation Agreement points out at this.
Q: Could you elaborate on the impact this will have on the local banks if the compliant process would not take place?
Theagarajah: When the process has not taken place then you are running the risk of any of those balances in one of those banks subject to the mandatory withholding. You can take the view that the fund manager will minimise the balance and take the view that it is not significant. There are repercussions beyond that. The fact that you are not compliant can shut you out of the system, which is a danger.
There is something else you have to be mindful of. The FATCA is just a start in the US. There is something mentioned called the CATCA that was started by the Canadians. For Sri Lanka I think Canada will be a bigger implication than the US. The message is that whether it is today or tomorrow, the processes of strengthening the compliance investment is going to be there. The sooner you start the better.
Q: As individuals are concerned how does FATCA treat dual citizens?
Makhijani: You will have to design the form in such a way that such information is captured. As for dual citizens they have no choice but to report.
Q: There are only few days left. Do you think in the legislation there is a risk in registering since there so much work afterwards? What
is your advice?
Theagarajah: There are two categories of legislation, either as a participatory financial institution, or as a limited one. From what we understand even though you register as the latter, at some stage in the future you can switch over to the former.
Q: While the US is confident in getting all the other countries to implement this, only 45 have come on board, and the IMF is in 146 countries. Is this a non starter? And in understanding the local secrecy laws I am sure the US would have understood the bottlenecks but still they went ahead. Is it because the situation was so bad for the US in terms of tax revenue?
Makhijani: Singapore has said that it will go with IGA. US-China regulatory dialogue, which took place in July last year, said that both the countries will accelerate the effort to continue the IGA. Hong Kong is keen to go with the Model 2 agreement and Australia is already amongst one of the 19 countries.
Q: What is the preparedness of the financial services sector?
Perera: In Sri Lanka the awareness is almost nil. The bankers and compliance officers have some sort of an idea but in the other sectors the awareness is less. There are about two months more and there are lots more to be done. You need to understand the 40 page document and KPMG is willing to help in this regard. |
